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Untitled-1 1 29/09/2017 10:26:28 Contents - Vol. 8 Ed. 11 December 2017 COVER STORY: 2017 winners and losers Monthly Review 6-7 Briefings – OMFIF Advisers Network, OMFIF meetings Power plays 2017 8 Macron fulfilling his reform agenda 2017 in review Jacques Lafitte Review of 9 Macri returns Argentina to world stage II OMFIF predictions the year David Smith VI Shortcomings in 10 Voters on the threshold of change leadership John Kornblum BTN_12.17_00i_focus COVER.indd 1 24/11/2017 13:01 11 10 myths about Brexit and the City William Wright International monetary policy 12 Stability of inflation after the financial crisis Nathan Sheets 9 13 Epoch-making scale of robotics Gary Smith Digital economy 14 Cryptocurrencies: growth and controversy Oliver Thew Sustainable investment 15 Getting the most out of green bonds Joaquim Levy Europe 16 New proposals on deposit insurance Stefan Bielmeier 18 17 ESM expands into dollar market Kalin Anev Janse Emerging markets 18 Aramco sale buttressing Saudi financial triad Elliot Hentov 19 Dealing with disappointment Burcu Ünüvar International trade policy 20 A new phase of trade expansion Otaviano Canuto 21 Perils of regulatory change Jodie Keane Book review 23 Beyond the theatrical skirmishing David Marsh OMFIF Advisory Board poll 26 End of bull market in sight 21

30 Crown Place, London, EC2A 4EB The Official Monetary and Financial Institutions Forum is an independent think tankfor United Kingdom central banking, economic policy and public investment – a non-lobbying network for best T: +44 (0)20 3008 5262 practice in worldwide public-private sector exchanges. At its heart are Global Public Investors F: +44 (0)20 7965 4489 – central banks, sovereign funds and public pension funds – with investable assets of $33.8tn, equivalent to 45% of world GDP. www.omfif.org With offices in London and Singapore, OMFIF focuses on global policy and investment @OMFIF themes – particularly in asset management, capital markets and financial supervision/ regulation – relating to central banks, sovereign funds, pension funds, regulators and Board treasuries. OMFIF promotes higher standards, performance-enhancing exchanges between John Plender (Chairman) public and private sectors and a better understanding of the world economy, in an atmosphere Jai Arya of mutual trust. Pooma Kimis Edward Longhurst-Pierce David Marsh Membership Mthuli Ncube Membership offers insight through two complementary channels – Analysis and Meetings – John Nugée where members play a prominent role in shaping the agenda. For more information about Peter Wilkin OMFIF membership, advertising or subscriptions contact [email protected]

Advisory Council Analysis Meghnad Desai, Chairman OMFIF Analysis includes research and commentary. Contributors include in-house experts, Johannes Witteveen, Honorary Chairman Advisers Network members, and representatives of member institutions and academic Phil Middleton, Deputy Chairman and official bodies. To submit an article for consideration contact the editorial teamat Louis de Montpellier, Deputy Chairman [email protected] Frank Scheidig, Deputy Chairman Songzuo Xiang, Deputy Chairman Meetings Otaviano Canuto Aslihan Gedik OMFIF Meetings take place within central banks and other official institutions andare Robert Johnson held under OMFIF Rules. A full list of past and forthcoming meetings is available on William Keegan www.omfif.org/meetings. For more information contact [email protected] John Kornblum Norman Lamont Kingsley Moghalu OMFIF Advisers Network Fabrizio Saccomanni Gary Smith Niels Thygesen The 178-strong OMFIF advisers network, chaired by Meghnad Desai, Ted Truman is made up of experts from around the world representing a range Marsha Vande Berg of sectors: Monetary Policy; Political Economy; Capital Markets; Ben Shenglin, Chair, OMFIF Economists Network and Industry and Investment. They support the work of OMFIF in a variety of ways, including contributions to the monthly Bulletin, Editorial Team regular Commentaries, seminars and other OMFIF activities. Danae Kyriakopoulou, Head of Research Membership changes annually owing to rotation. Simon Hadley, Senior Production Manager Julian Frazer, Subeditor Ben Robinson, Senior Economist October 2017 July-August 2017 Bhavin Patel, Economist The Bulletin Vol. 8 Ed. 9 The Bulletin Vol. 8 Ed. 7 Kat Usita, Researcher Green finance heats up William Coningsby-Brown, Editorial Assistant Public investors to the fore Darrell Delamaide, US Editor Future of finance Facing digital disruption Marketing Jean-Jacques Barbéris on Macron’s challenge Tiago Berriel on Brazilian economic revival Evelyn Hartwick on financing sustainable investment Bertrand de Mazières on green bond regulation Chris Ostrowski, Assistant Head, Business Development Paweł Kowalewski and Ben Robinson on central bank divergence Vicky Pryce on Varoufakis’ EU battle

Hiromi Yamaoka on distributed ledger technology Pēteris Zilgalvis on Europe’s digital single market Matthew Saal on emerging market fintech innovators Otaviano Canuto on Brazil’s corruption investigations Alan Budd on Britain, Europe and Black Wednesday Strictly no photocopying is permitted. It is illegal to reproduce, store FOCUS on Madrid: opportunities in Europe and Latin America

BL_10.17_001_COVER ideas.indd 1 02/10/2017 12:49:42 in a central retrieval system or transmit, electronically or otherwise,

May 2017 April 2017 March 2017 any of the content of this publication without the prior consent of the The Bulletin Vol. 8 Ed. 5 The Bulletin Vol. 8 Ed. 4 The Bulletin Vol. 8 Ed. 3 publisher. While every care is taken to provide accurate information, Oil in twilight zone the publisher cannot accept liability for any errors or omissions. No Catalysing Opec reform responsibility will be accepted for any loss occurred by any individual Shock and renewal due to acting or not acting as a result of any content in this publication. Challenges for Europe On any specific matter reference should be made to an appropriate

John Anyanwu on sub-Saharan Africa Meghnad Desai on Greenspan’s flaws Rabah Arezki on oil price stability adviser. Brigitte Granville on Le Pen’s popularity Gautam Sashittal on gold opportunity Felix Hufeld on banking regulation Ikuko Samikawa on Japan’s monetary policy Gender matters David Marsh on the Scottish conundrum Amando Tetangco on Asia’s ‘new mediocre’ Mthuli Ncube on mobile banking FOCUS on Portugal Women in central banks Company Number: 7032533 Sayuri Shirai on Japan’s yield curve Global Public Investor Gender Balance Index Danae Kyriakopoulou on Greek debt Christine Lagarde on women’s empowerment ISSN: 2398-4236 Vicky Pryce on employment quotas Minouche Shafik on the role of experts Tarisa Watanagase on aging demographics

ompared with the shock-filled 2016, this year saw the electoral pendulum swing back towards the mainstream. While populist forces Cgained ground in important polls across Europe, veteran figures held on to power, much to the relief of those worried about the prospect of a collapsing liberal world order. Jacques Lafitte emphasises new French President Emmanuel Macron’s progress on tax and labour reforms, while David Smith praises President Mauricio Macri’s achievement of cutting inflation in Argentina by half. John Kornblum reassuringly argues that, despite the breakdown in coalition talks, Germany will maintain stability. In Saudi Arabia, Crown Prince Mohammad bin Salman took steps to address corruption – and, it seems, buttress his own power, ordering the arrest of several hundred policy-makers and businessmen. Elliot Hentov emphasises the need to build capital markets to facilitate economic development in the kingdom. Further east, both Xi Jinping and Shinzo Abe consolidated their power in China and Japan, setting the scene for a possible revival in co-operation, writes Adam Cotter. In this month’s Focus report we review the OMFIF Advisers Network’s predictions for 2017 against the course of events. Overall, OMFIF advisers did well. Our advisers rightly predicted the Brazilian economy would stabilise in 2017 and that Chancellor Angela Merkel would be unable to win an outright victory in Germany’s election. Where our advisers were less surefooted was in forecasting dangers that have not (so far) materialised, such as Donald Trump sparking global market volatility and the possibility of armed conflict between the US and China. An unperturbed passage to 2018 is far from guaranteed. Britain remains in the spotlight. There are still considerable risks from the Brexit negotiations, as well as reasons to be optimistic, writes David Marsh in his review ofClean Brexit: Why Leaving the EU still makes sense, while William Wright debunks 10 myths about Brexit’s impact on the City. Europe will have to make important choices as it seeks to reform its political and financial architecture. One institution that is widely expected to play a bigger role is the European Stability Mechanism. Kalin Anev Janse, its general secretary, explains the rationale behind the ESM’s first dollar bond. Stefan Bielmeier highlights that decisions on a European deposit insurance scheme must take account of the risks inherent in a fragmented banking system. Central bankers will also be tested. Despite extraordinarily loose policies they are failing to reach their inflation targets at the same time as negative side-effects are gathering increasing attention, notes Burcu Ünüvar. Nathan Sheets compares central bankers’ records in the pre- and post-crisis periods, while Gary Smith focuses on the role of technology in determining inflation. Structural shifts in the world economy are also transforming global value chains and international trade activity, according to Otaviano Canuto and Jodie Keane. But the bull market may not last, as members of our Advisers Network predict in this month’s poll. On a more positive note, we have seen undoubted progress in development of financial instruments backing efforts to combat climate change. Over 2017, the market for green bonds doubled. Joaquim Levy underlines the need to demonstrate the value of such instruments to investors – setting the scene for a range of OMFIF activities in 2018 supporting ‘green finance’ initiatives around the globe.

Global role for China, Japan will grow Economic connections overcome frosty relations Adam Cotter i Jinping and Shinzo Abe, the Chinese and Japanese leaders, have reinforced their positions in the last few months , providing a solid Xplatform for enhancing bilateral co-operation including in economic and monetary affairs. From these positions of strength, the Chinese president and Japanese prime minister can look in 2018 towards ironing out divergences, not least over territorial claims and differing interpretations of history, which remain impediments to the ambition of realising the ‘Asian century’. Although relations remain tinged with frost, much has improved in the six years since Abe and Xi assumed power in 2012 amid rising tensions over the disputed Senkaku/Diaoyu islands in the East China Sea. China is Japan’s largest trading partner, while Japan is China’s second-largest. Japan, benefiting from China’s outbound tourism boom, has welcomed around 5m Chinese visitors in 2017, more than from any other country. As US President Donald Trump continues to advocate unilateralist policies and a protectionist approach to global trade, the international role played by Asia’s two largest economies appears likely to increase. Developments in North Korea will demand both countries’ involvement. Japan risks being left behind as an increasingly confident China seeks a bigger say in the global economic and security order. Xi is urging further regional economic integration and greater co-operation on trade and investment. Aside from the Beijing-led Regional Comprehensive Economic Partnership, he is proposing further talks on a free trade agreement between China, Japan and South Korea. Trump’s withdrawal of the US from the 12-nation Trans-Pacific Partnership trade agreement – which does not include China – was a setback for Abe. However, talks on a new iteration of the deal following November’s Asia-Pacific Economic Co-operation summit in Vietnam are promising – even though Canada may be absent. At the same time, Xi has seen almost 70 countries sign up to his signature Belt and Road infrastructure initiative. Although it would be politically difficult, Japan’s greater involvement in the Belt and Road would be hugely beneficial for the region. China’s rise has engendered much speculation about the international role of the renminbi. Its inclusion in the special drawing right, the International Monetary Fund’s composite currency unit, has met much fanfare. Japan has sporadically attempted to internationalise the yen. The future currency system for Asia remains an open question. China and Japan may jointly work towards an answer more quickly than many think. ▪ Adam Cotter is Head of Asia at OMFIF.

‘If the euro area economy continues to perform well, the ECB has good reason to “taper” asset purchases at end-September 2018.’ This is according to Ewald Nowotny, Oesterreichische Nationalbank governor, at an OMFIF City Lecture in London on 3 November. So far the ECB has been careful to talk not about ‘tapering’ but rather of lowering the pace of bond-buying. Nowotny also focused on the European Central Bank’s role in the euro area recovery, prospects for deeper euro area integration, and the strengthening of monetary and fiscal policy on strengthening the Austrian economy.

The UK and Europe: where are we heading? OMFIF convened a lunch discussion in London with Chuka Umunna, Labour Member of Parliament for Streatham since 2010, who served as Shadow Business Secretary 2011-15. The discussion on 7 November examined the Brexit negotiation process, the role of parliament, the nature of a transition arrangement and the future relationship between the UK and Europe. Prospects of further Avoiding the cliff edge referendum

On 9 November, OMFIF organised a Sir Vince Cable, leader of the Liberal roundtable briefing in London with Democrats and Member of Parliament Kenneth Clarke, Member of Parliament for Twickenham, discussed the UK’s for Rushcliffe, father of the House of withdrawal from the EU at an OMFIF Commons, and former Chancellor of the briefing on 29 November in London. Exchequer (1993-97). Clarke expressed Topics included the Liberal Democrats’ his views on Britain’s tortuous exit talks perspective on the impact of Brexit; ahead of a parliamentary and diplomatic the prospects for a second referendum, struggle on the government’s EU and the role of parliament in the withdrawal strategy. withdrawal process.

6 | MONTHLY REVIEW omfif.org December | ©2017 Greening infrastructure Forthcoming meetings investment Implementing Basel III As instruments of public policy, multilateral A discussion with William Coen, Secretary development banks must lead as ‘torch bearers’ in General, Basel Committee on Banking making financing sustainable, compared to other Supervision. The discussion focuses on the financial institutions. That was a key message at challenges with Basel III accord, the state of an OMFIF-DZ BANK roundtable in Beijing on the global financial regulation and measures to global green finance agenda and investing for a enhance financial stability across countries. sustainable future in Beijing on 24 November. 5 December, London

Monetary policy and global capital markets Launch of John Mourmouras’ book, Speeches on Monetary Policy and Global Capital The implementation of Markets 2015-2017. The themes include monetary policy European Central Bank monetary policy, developments in global capital markets, and The European Central Bank has reiterated that the future of Greece in Europe. it will decide in the autumn on the calibration 6 December, London of its policy instruments beyond the end of this year. Against this background, Joachim Reviewing Germany’s economic policy Wuermeling, member of the executive board A roundtable with Volker Wieland, of the Deutsche Bundesbank, discussed the Managing Director, Institute for Monetary operational challenges in the implementation and Financial Stability and member of the of monetary policy, in a lunch discussion in German Council of Economic Experts. The London on 22 November. discussion focuses on reforms in Germany, the political environment, shifting monetary policy, and euro area stability. 7 December, London

Saudi Arabia’s Roundtable for public sector asset managers An investment meeting with a group evolving economy of economic experts and asset managers, mainly from a public sector Fahad Ibrahim Alshathri, deputy governor background, to summarise economic for research and international affairs at the and financial developments and discuss Saudi Arabian Monetary Authority, took the outlook for public sector investment part in a breakfast discussion in London on management in Europe. 13 November. He focused on developments 30 January, London in Saudi Arabia’s economy, including diversification and growth in the financial For details visit www.omfif.org/meetings services sector.

Green infrastructure Unfinished Business The challenges of A new phase of investment discussion climate change monetary policy Ludger Schuknecht, of the German OMFIF organised a lunch discussion Anne Le Lorier, first deputy Asset bubbles in world bond Ministry of Finance, took part in on 7 November in London with governor Banque de France, gave markets and rising inequality a lunch discussion in Singapore Tamim Bayoumi of the IMF, focusing a City Lecture in Singapore on 14 in Japanese society formed the on 15 November. He focused on his new book Unfinished November. She discussed financing agenda at the second annual on sustainable investments business: The unexplored causes of flows into low carbon activities, the Japan Center for Economic and developments in fiscal and the financial crisis and the lessons definition of ‘green’ investment Research-OMFIF seminar in Tokyo international policy. yet to be learned. and proposed incentives. on 22 November.

December | ©2017 omfif.org MONTHLY REVIEW | 7 Macron fulfilling his reform agenda President is answering critics’ greatest concerns Jacques Lafitte, Avisa Partners rench President Emmanuel Macron competent minister, Jean-Michel Blanquer. Fwas elected in May on – some would The unions are unhappy but are staying quiet, say despite – a platform of far-reaching since Blanquer enjoys strong public support. economic reform. During the election campaign, law and He surmounted this obstacle with a order was considered Macron’s weak point. substantial loosening of labour rules. In a country wounded by terrorist attacks, Together with Muriel Pénicaud, his astute he was perceived by many as too lenient employment minister, Macron has managed or insufficiently concerned. Whatever kind to subdue France’s combative unions without of candidate he was, President Macron has having to call in riot police; he is burying played the part of strongman. In November, them under consultations. together with Prime Minister Édouard Philippe, Pénicaud has conducted 300 hours of he ended the two-year state of emergency, closed-door talks with union bosses. This but skilfully managed to make into law all approach isolated the General Confederation measures that intelligence services and police of Labour (CGT), the unreformed communist forces wanted to keep. In the country which union, and France Unbowed, a left-wing claims it invented human rights, opposition to ‘President Macron has played the part of strongman’ populist political party. Demonstrations and the law was remarkably subdued. blockade attempts quickly collapsed. The next But the biggest surprise with Macron is that leftist mobilisation might not be so simple. he is such a gifted diplomat. He would have Macron and Bruno Le Maire, the finance had all reasons to hate US President Donald boldest vision for transforming the continent minister, are busy with tax reforms, with the Trump and Russian President Vladimir Putin, by a European leader for 25 years. stated aim of enfranchising entrepreneurs. yet managed in record time to become their Macron’s status as a beacon of European The main change in the 2018 budget – the friend on the world stage. In the complicated hope helped him realise a major tactical replacement of the damaging wealth tax by a Middle East he is an ally to many and the enemy victory with the reform of the ‘posted workers’ mere real estate tax – is already assured. The of no one. He played his part in convincing directive, which relates to employees who are government is reforming France’s dysfunctional Trump not to annul the Iran nuclear deal and sent to carry out a service in another EU state. vocational and further training processes. helped to exfiltrate Lebanese Prime Minister This is a point of great contention in France, and Results are starting to show. Business Saad Hariri out of Saudi Arabia. the bane of former presidents. Macron achieved confidence is at its highest in more than 15 almost 90% of what he wanted, managed to years, and corporate investment is up. The split the Visegrad group and isolated Poland, net creation of factories in France turned It is too early to say the only country which he openly scorns. The positive last year, in part because of Macron’s next step will be reform of the euro area. first labour law reform when he was economy whether Macron’s minister in 2015, and the trend is accelerating. plans will succeed, but they Popularity an afterthought for Macron Macron’s greater test will come next year comprise probably the boldest Macron’s image is far from stellar. Ironic with the unification of France’s myriad pension nicknames range from Jupiter to Napoleon. schemes. The public sector ones are very vision for transforming the As always, the French are tougher than other generous – and totally imbalanced – though “ electorates on their rulers; Macron lost more continent by a European the French do not find this unfair. People still support in his first six months in office than vividly remember the previous attempt at leader for 25 years. former President François Hollande, infamously unification, in 1995: there were three weeks France’s least popular leader. But such statistics of general strike, ending with the government miss several key factors. If the presidential dropping its plans for pension reform. There Closer to home, German Chancellor election were to be re-run today, Macron’s first are many reasons to believe that the outcome Angela Merkel is a big fan of Macron. They round score would increase to 28% from 24%. will be different for Macron, though some have returned Franco-German relations to Macron was elected on a centrist platform caution is warranted. The CGT is likely tobe their zenith. Macron’s relations with UK Prime but predominantly by centre-left voters. It joined in protests by Workers’ Force, one of Minister Theresa May are more than cordial. turns out that he is running a centre-right the other major union confederations with a Although he is a hardliner on Britain’s exit programme. The much-reported drop in strong civil servant base. from the European Union, he has managed opinion polls was unavoidable. But it is to put Merkel on the front line of the debate. reversible: Macron’s popularity jumped 4% in Success at home and abroad In a speech at the Sorbonne university November from the month before. There are other major problems that Macron in September, Macron set out his plans for What matters most is that Macron says he must contend with. French primary and a ‘profound transformation’ of the EU. He does not care about his approval ratings, and secondary education have decayed for advocated common EU policies on defence, everything suggests he really doesn’t. ▪ decades. Until the last couple of years, the asylum and tax, called for the formation of education ministry was run by all-mighty European universities, and promised to play Jacques Lafitte is founder at Avisa Partners, Brussels, teachers’ unions. It will take several years the EU anthem at the Paris Olympics in 2024. and formerly oversaw the euro dossier in the Cabinet for the education system to recover, but the It is too early to say whether the plans will of Yves-Thibault de Silguy, Economic and Monetary downward spiral has been stopped by another succeed, but they comprise probably the Affairs Commissioner, 1995-99.

8 | POWER PLAYS omfif.org December | ©2017 Macri returns Argentina to world stage Cutting inflation, improving competitiveness are priorities David Smith, Advisory Board his has been a year of living dangerously The weeks since have involved long days For the next 12 months Macri’s Tfor the reform-minded government and nights of negotiations on everything government could find renewed success of Argentine President Mauricio Macri. from the way the central government on the international stage. Between 10-13 Nonetheless, by almost common consent funds the provinces, to labour reforms, to December in Buenos Aires the World Trade in Argentina, Macri is heading into 2018 overhauling the vast state pension system, Organisation will hold its annual ministerial backed by favourable conditions and to a new tax code. meeting. It will be chaired by Susana Malcorra, moving towards fulfilling a large measure of ‘What drives policy now is reducing the experienced United Nations figure who his country’s huge potential. inflation and the need to shrink the served as Macri’s first foreign minister. On a visit to New York to court foreign public deficit, to make us so much more investors following a midterm election victory competitive,’ to quote a Macri adviser, on 22 October that points to his probable re- expressing relief that this pivotal year ends This is just the election in 2019, Macri was bullish about the without the unrest that brought down non- beginning of a deep prospects for his reform programme. Peronist predecessors. ‘High inflation keeps ‘We’ve turned the corner in Argentina. our social spending inflated, and keeps and constant cultural change This is just the beginning of a deep and us reliant on external debt to finance the in our country, intersecting constant cultural change in our country, deficit. This has to stop.’ economic and politics. intersecting economic and politics,’ he told “ lead players on Wall Street. ‘The key is telling On the world stage ourselves the truth, and being confident Public opinion suggests Macri will defy Next year Macri will host the annual enough in ourselves to face the truth. We’re recent history and become the first non- summit of the G20, the first in South getting there.’ Peronist leader to complete a term in America. The president’s role will be greatly office, let alone win re-election. Corruption changed from that of his first G20 meeting in Inflation and widespread poverty scandals have made Peronism synonymous 2016, and entirely distinct from the first G20 Macri’s government has cut inflation in half, with grand theft. Senior figures from the summit in Washington in 2008. That day, the down to 22% as the year ends. The economy, Kirchner era are in prison, including the leaders managed to pose for the first group which shrank by 2% in 2016, has rebounded last vice-president and the minister who photo without then-President Kirchner, who and is on track to grow by 2.7% this year. The oversaw tens of billions of dollars’ worth of managed somehow to be out of the room. enormous deficit Macri inherited is falling, to public works. The ambitious and reformist Macri is much a projected 3.2% of GDP in 2018 from highs ‘The alternative to Macri is seen, day after more likely to be welcomed by the crowd. of 6%. But the challenges ahead remain day, to have been stealing on an unimaginable ▪ daunting. Without expansive reforms, Macri scale,’ says a leading pollster. ‘Macri, and his David Smith is a Member of the OMFIF Advisory Board admits his grand project cannot succeed. successors, may have long life as Peronism and represented the United Nations Secretary-General in ‘My first commitment is to reduce sinks in the gutter.’ the Americas between 2004-14. widespread poverty, and that will take many years,’ he says, acknowledging he still doesn’t have control of congress. ‘Reducing inflation, to single digits, alongside reforms creating good jobs, that’s my number one priority, because inflation hurts the poor most.’ The government secured a substantial victory in the midterm elections, sweeping the country’s main population centres. Macri

Reducing inflation, to single digits, alongside reforms creating good jobs, that’s my number one “priority, because inflation hurts the poor most.

defeated key populist Peronist opponents, including former President Fernández de Kirchner, in the province of Buenos Aires, the most important stronghold and home to Macri (far left) sitting alongside Barack Obama and Angela Merkel at the 2016 G20 summit almost 40% of the population.

December | ©2017 omfif.org POWER PLAYS | 9 Voters on the threshold of change Slow-moving Germany sees new definition of stability John Kornblum, Advisory Council hen I first arrived in Hamburg as a vice- expansionism and Germany’s recession led to Over the last 20 years, two chancellors have Wconsul more than 50 years ago, every a call for new leaders and new ideas. Peace, led Germany. The first, Gerhard Schröder, was aspect of public life appeared to be frozen. detente and the welfare state were the answer. ousted in 2005 after seven years in office for Ludwig Erhard, father of the post-war West I cannot help thinking of those days as changing things too quickly. Merkel vowed German economic miracle, was confirmed as pundits puzzle over the dramatic collapse never to repeat her predecessor’s mistakes. chancellor in the September 1965 election. of Chancellor Angela Merkel’s efforts to She even managed to sell the dramatic The Berlin wall built in 1961 seemed to have build a new Berlin coalition after her poor abandonment of forward-thinking nuclear sealed Europe’s division more deeply than performance in the 24 September elections. power as a necessary reaction to a tsunami in ever. German democracy was robust and the So much has changed, but so much remains nuclear-heavy Japan. US reigned supreme as Germany’s saviour the same. The advice I received as a young and civilisational model. man seems to have been borne out. Fresh faces Less than two years later, Erhard had In the age of Donald Trump, realisation Regardless of how confusing such behaviour been toppled, Ostpolitik (the normalisation of the western democratic vision depends seems to outsiders, it appears to serve an of relations between West Germany and significantly on Germany’s ability to remain a important purpose in Germany. Observers the East) headed the political agenda, and strong and confident partner in both Europe must be careful neither to overestimate Germany was experiencing its first post-war and across the Atlantic. Understanding the immediate implications of what is recession. The war in Vietnam tarnished events in German has suddenly become a happening, nor to underestimate the Washington’s image, and the far-right major international task. country’s ability to adjust to change. National Democratic Party threatened the Germany experienced exceptional upheaval stability of German democracy. Slow pace of change in the 1970s and 1980s, only to enjoy great An old and experienced observer advised At first glance, Germany seems to have been stability afterwards. me, ‘Germany always takes a long time to infected by the same dynamics which burden A small insight into the national mood was change, but when stability seems to be the rest of the West – a turn to political provided by an online poll conducted by the populism and protectionist rhetoric. This German daily Die Welt. Of more than 100,000 is true to some extent, but the underlying readers who responded, 72% welcomed the A slow pace of change causes are more long-term in nature. decision on 19 November by Christian Linder, What people are observing in Berlin is the leader of the liberal Free Democratic Party, is typical of German inevitable erosion of a political consensus the would-be junior member in Merkel’s political life. Voters seem which has endured since the fall of Chancellor coalition, to abandon negotiations. to demand an emotional Helmut Kohl in 1998, who was defeated in This suggests voters are looking for fresh federal elections by a large margin against the faces and new approaches, and that Lindner insurance policy before backdrop of rising unemployment. German may have struck the right note. But, for the “ voters are seeking a new definition of stability. time being, his success reflects more the agreeing to anything new. A slow pace of change is typical of German novelty of a new personality, rather than new political life. In a nation traumatised by policy. Partners in Europe should take note, in danger, voters strike back rapidly and violent upheavals, voters seem to demand an as I learned many years ago, ‘You can never dramatically. And you can never tell which emotional insurance policy before agreeing tell which way Germany will go.’ way their drive for stability will take them.’ to anything new. Governments and leaders ▪ The next few years more than proved this stay in office much longer than elsewhere. John Kornblum is a former US Ambassador to Germany, prediction true. By the mid-1970s things had When change comes, it is usually defined as Senior Counsellor at Noerr LLP, and a Member of the changed almost beyond recognition. Soviet being much more dramatic than it really is. OMFIF Advisory Council.

New dawn: 'Voters are looking for fresh faces and new approaches‘

10 | POWER PLAYS omfif.org December | ©2017 10 myths about Brexit and the City Bank restructuring and fintech are greater threats William Wright, New Financial lmost 18 months after the British referendum to leave the 20,000 jobs after Brexit – about 2% of the total number of people AEuropean Union, politicians and market observers continue to working in financial services in the UK. A few percent here and there debate the potential impact of Brexit on the City of London, the will quickly add up. centre of the UK’s financial services sector. But the debate is often dominated more by fiery quarrelling than reasoned deliberation. 6. The EU needs the City more than the City needs the EU Myths and delusional thinking permeate both sides of the argument. The City plays a vital role in lubricating the EU27 financial system. More than 75% of all foreign exchange and derivatives trading in the 1. Brexit will kill the City EU takes place in London, and between 50%-70% of all investment Some of the more fervent supporters of the Remain campaign say banking activity, equity trading and bond trading in EU27 markets is that, in a few years, the City of London will be left barren after a conducted in London. mass exodus of banks and asset managers to Frankfurt. But only But banks that conduct that business in the City today will move around 25% of business in the City is EU-related, and much of that as many functions as necessary to the EU27 to ensure that they can will be able to stay in London. conduct it in Frankfurt or Paris tomorrow. UK banks’ exposure to EU While firms will have to move some operations to the EU, counterparties is about 4% of the total EU financial system, while EU most of their business will stay and London will continue to be banks represent about 30% of all activity in the UK. the dominant European and global financial centre. The Bank of England’s latest estimate of 75,000 job losses would be a 7. The relocation of euro clearing will cost tens of thousands of jobs substantial blow, but that figure amounts to less than 8% of the UK Some countries would love to force the €1tn-per-day of euro- financial services industry. denominated clearing that takes place in London to move to the EU. The EU itself wants a larger role in the supervision of this business 2. Brexit is the biggest threat to the City (much as US regulators have joint oversight of US clearing houses in Brexit is not even the greatest risk to the City. The impact of technology London). But the EU would only push for relocation if it thought the and the acceptance that the pre-2008 financial crisis heydays are UK’s supervision was too relaxed. never coming back will force banks to automate, outsource and To argue that tens of thousands of UK jobs will be lost one must offshore many of their functions. assume the EU will demand that all activity related to the euro must Brexit is the occasion and not the cause: it will concertina decisions take place inside the EU. This is not practical because it would lock the about restructuring that might not have taken place for years. EU out of the global financial system. Employing thousands of support staff in London or other UK cities like Bournemouth or Manchester suddenly looks tremendously expensive 8. Financial technology will save the City compared with European cities such as Krakow or Riga. This process The rapid growth in the fintech sector and London’s dominant position in will probably cost far more jobs than Brexit itself. Europe has been a welcome boost for the UK over the last few years and created around 60,000 jobs. That will probably offset any Brexit-related 3. Brexit will liberate the City from the burden of EU regulation job losses in the short and medium term. However, the point of fintech is Those who hope Brexit will liberate the City from EU bureaucracy to disrupt banks’ business models: the more successful fintech becomes, should listen more closely to the messages being transmitted by the more jobs it will destroy in traditional banking. There will be more the Bank of England, the Financial Conduct Authority and the UK competition and better products for consumers, but fewer overall jobs. Treasury. Mass deregulation will not happen. A lot of EU regulation was designed in the UK, and the UK often ‘gold plates’ EU rules 9. A transition period will save the City to make them tougher. There is scope for the UK to soften some City-based banks and trade associations have been warning that unless regulation – perhaps there could be a separate regime for smaller the UK agrees a ‘status quo’ transition agreement with the EU in the domestic firms – but the country has been at the vanguard of coming months, firms will have put their Brexit relocations plans into helping set global rules, and wants to stay there. action. This transition period would involve agreeing, in advance of a trade deal, that for two years after Brexit the UK’s relationship with 4. The EU has held the City back the EU would essentially stay the same – apart from the UK having no While Europe is an important market for the City, it is hard to argue that say in the rules it would have to apply. While it is an elegant idea, to London has been held back when two-thirds of its financial services many people it would look remarkably like an attempt to derail Brexit. exports go to the rest of the world. One of the many reasons why the City’s importance has grown over the last few decades is that firms are 10. A bespoke deal can be reached before we leave able to concentrate their European activities in one place under single It is misguided to believe a comprehensive trade agreement that market rules. Big US and Swiss banks employ more than 60,000 people includes financial services – or a bespoke deal for the City – can be in the UK, and tens of thousands more work at large Asian banks. negotiated in the next 15 months. The only comprehensive trade deal to include financial services ever agreed is the EU itself, which is a 5. Frankfurt wants to steal all of the City’s business work in progress that has taken decades to develop. It is deceptively easy to argue that Paris or Frankfurt are not going For context, discussions about Mifid II, the latest EU directive that to be able to replicate immediately what the City has built up over comes into force in January 2018, began in 2010. The proposal to develop centuries. After all, roughly the same number of people work in and a system of mutual recognition for UK and EU financial services regulation around the City as the entire population of Frankfurt. is an excellent idea, but will take more than a decade to shape. But no financial centre in the EU has any plans to take allof ▪ London’s business: they are after portions of it. Paris wants to attract William Wright is Managing Director of New Financial, a capital markets think tank.

December | ©2017 omfif.org POWER PLAYS | 11 Stability of inflation after the financial crisis Central bank vigilance essential to maintain equilibrium Nathan Sheets, PGIM Fixed Income ow and steady inflation has been a central cautionary tale for central banks, highlighting financial markets. This is of central importance Lfeature of global economic performance how difficult it is to dislodge deflationary in explaining the low levels and relative stability over the last 15 years. In the period before expectations once they become entrenched. of longer-term bond yields. It means investors the 2008 financial crisis, global headline Third, the centre of the distribution of core have good empirical reasons for requiring inflation cycled around 3%. After showing inflation outcomes is nearer 1.5% than 2%, low inflation compensation for holding some volatility during the financial crisis, and inflation has apparently run somewhat bonds and for demanding relatively small reflecting sharp moves in commodity below central banks targets particularly in compensation for inflation risk. The inflation prices and the severe economic downturn, the post-crisis period. A deeper question process appears to have shifted relative to aggregate headline inflation fell to around is whether meeting inflation targets with previous decades, which is reflected in these 2%. In the last two years it dropped further greater precision is practically achievable for bond pricing features. The stability of inflation still as commodity prices fell sharply. central banks. contributes to a more stable macroeconomic Similarly, global core inflation trended environment, which should reduce financial down during the first half of the last decade, Policy maturity in emerging markets risks premiums more generally. but then stabilised near 2% before dropping Inflation performance in the major Central banks are crucial to this story. The between 2009-11. Following the crisis, emerging markets splits these economies stability of inflation reflects how effective core inflation returned to 2%, where it has into two groups. One set of countries with monetary policy-makers have been over remained since early 2012. relatively high inflation in the pre-crisis the last 15 years. They have responded to These similarities in inflation period – Turkey, Russia, and Indonesia shocks in ways that have helped deliver performance are striking in the light of the – has achieved markedly lower inflation stable inflation and, accordingly, inflation divergent economic conditions in the years since the crisis, although Turkey has given expectations in both the real economy and before and after the crisis. The pre-2008 back some of these gains over the last in financial markets have reinforced these period saw rapid growth, building leverage two years. Many other emerging market efforts. To preserve this equilibrium, central in the financial system, and overheating in economies have seen fairly stable inflation, banks must be vigilant and prepared to asset markets. The post-crisis period has much like the advanced economies, albeit respond to emerging inflationary risks. seen softer growth and a gradual reduction with moderately higher average rates and ▪ in unemployment rates. Financial markets somewhat more variability. These results Nathan Sheets is Chief Economist and Head of Global have been recovering through the post-crisis are broadly encouraging. That inflation in Macroeconomic Research at PGIM Fixed Income, and period, but there is much less leverage in many of these emerging countries has moved former Under Secretary for International Affairs in the the core of the system than before 2008. In lower or become more stable confirms their US Treasury department. The information in this essay is addition inflation has typically shown, both increasing policy maturity and the strength of drawn from publicly available sources and represents the before and after the crisis, little imprint of their core institutions. views of the author as of 15 November 2017. These views variations in resource slack – the Phillips The relative stability of inflation across do not constitute investment advice, are for informational curve has been very flat. the globe has had important implications for purposes only, and are subject to change.

Central bank inflation objectives To examine the underlying drivers and Global inflation has remained subdued features of global inflation, PGIM studied Headline and core global inflation, %, year on year inflation data for before and after the financial crisis relating to a group of 18 advanced and 6 emerging economies. These economies – namely the US, euro area, Japan, the UK, Australia, Canada, Brazil, Chile, Mexico, 5 China, India, Indonesia, South Korea, Poland, Russia, Saudi Arabia, South Africa and Turkey 4 – account for around 85% of global GDP. Inflation performance in the advanced 3 economies has been remarkably stable. Headline inflation has fallen somewhat, in 2 line with the drop in commodity prices, but the path for core inflation is similar in the pre- 1 and the post-crisis periods. There are several reasons for this. First, 0 central banks have clearly been successful in their long-term efforts to prevent inflation from escalating. In both periods, inflation does not typically stray much above 2%. Second, with the exception of Japan, Headline Core central banks have successfully avoided deflation. Japan’s experience has become a Source: Haver Analytics and PGIM Fixed Income

12 | INTERNATIONAL MONETARY POLICY omfif.org December | ©2017 Epoch-making scale of robotics Technological change too fast for labour markets to absorb Gary Smith, Advisory Council he headlines read, ‘Las Vegas self-driving Instead, automated rigs requiring a crew of created by disruption are making it more Tbus crashes two hours after introduction only five are replacing those that required a difficult to identify the longer-term benefits. of service.’ We later learned the bus was crew of 20. Perhaps the positive effects will become clearer, stationary at the time and that the human The critical question from a labour but, in the meantime, people are becoming driver of the second vehicle was issued with market perspective is what happens to these angry with these far-reaching changes. a driving misdemeanour ticket. displaced workers. Perhaps, like horse-drawn In terms of wages, it is difficult to believe that In the US and Europe, the story behind carriage drivers in 1920s New York, they get job dislocation, and a period of unemployment, automation is usually told from the perspective better jobs earning more money. But then is beneficial for aggregate income growth. of a threat, whether to road safety, job security, again, perhaps they take a lower-paid job as a Dislocation is more likely to result in wage wages, or the accepted way of life. temporary measure. Perhaps that temporary acceptance, rather than encouraging wage- In Japan, the story is markedly different. position becomes permanent. Perhaps these demanding behaviour. As Claudio Borio of the Machines are filling a gap created by a workers need to relocate to find a new job, Bank for International Settlements wrote in last shortage of workers. The government’s ‘Japan made difficult by the fall in labour mobility in month’s edition of The Bulletin, technological revitalisation strategy’ highlights a key role for the US economy. For the newly unemployed advances threaten labour’s pricing power. robotics, and proposes a ‘robot Olympics’ to rig worker, there is no evidence of a formal Technological change is another factor weighing run alongside the official games, scheduled industry- or government-sponsored retraining on wage inflation statistics, and confounding for Tokyo in 2020. The report states that programme, only self-help websites. advocates of the Phillips curve (which robot technology will improve corporate The days when low-skilled labourers were illustrates the inverse relationship between profitability, thereby ‘helping to raise wages’. most at risk from automation are behind us. unemployment and inflation), including those This contrast in perception is fuelled Studies show that mid-skilled workers are at the US Federal Reserve. primarily by differing demographic backdrops. more at risk from disruption. A robot could, In the longer term, robotics and artificial Japan is aging and shrinking. The population is undoubtedly, be designed to cut hair, but intelligence might be a more positive story. around 127m, and 25% are at least 65 years developing that technology is not worthwhile But, while we wait, societies may have to work old. In 40 years, the population might be just when it costs only £20 for a haircut. Robots harder to deal with short-term disruption. Bill 100m, with 40% of people 65 years old and have moved up the value chain. Instead of Gates has raised the idea of taxing robots, over. cutting hair, they are piloting planes, trains on the basis that every lost worker is a lost In the West, although industries do not need and automobiles (although, for the time income tax payment. That tax could be used robots to address such an acute demographic being, largely under human supervision). to pay for retraining programmes. problem, automation will become more And in the very long term, if human labour widespread. Multinational companies are the Popular anger is indeed rendered redundant by automation, key factor, and their motivation to increase While useful, the rig worker example might then the world’s economic problems will profits will accelerate the rate of investment in be said to overstate the extent of machine become one of wealth distribution rather than new technologies. substitution for human labour. This is because wealth scarcity. This would inspire arguments it does not account for the complementarities for society-changing measures such as Displaced workers between automation and labour that increase universal basic income. The implications could In 1900, 40% of the US workforce were productivity, raise earnings, and boost the be epoch-making in scale. employed in agriculture. By 2000 that figure overall demand for labour through supply ▪ had fallen to 2%, but food production and and ancillary industries. But concerns remain Gary Smith is a Member of the OMFIF Advisory Council overall employment rose significantly. In the that the pace of technological advancement is and Member of the Strategic Relationship Management 1920s cars replaced horses as the main form becoming so rapid that the short-term waves Team at Barings. of transport in US cities. This was a more rapid disruption, but was still generally recognised US rig count spikes but employment in oil & gas extraction drops as a job-positive story. Total rig count and oil and gas extraction workers, 2015-17 The risk today is that the pace of technological advancement is too fast for labour markets to absorb easily. This could have a pronounced impact on employment, wages and populist politics. Developments in the US oil industry illustrate this effect (see Chart). Between 2015 and mid-2016, the number of rigs halved in response to the oil price decline. A recovery in the oil price and improvement in the efficiency of production – driving down the required break-even oil price – led to a rebound in the rig count to almost early 2015 levels. Oil and pr u t an pr u t an pr u t gas industry employment fell in line with the ota ri ount (left) i as etration orers, thousands (right) decline in the rig count, but has not responded Demonstrating that green bonds offer higher risk-adjusted returns requires more empirical evidence to the increase over the last 12 months. Source: Baker Hughes Rig Count, US Department of Labor

December | ©2017 omfif.org INTERNATIONAL MONETARY POLICY | 13 Cryptocurrencies: growth and controversy New products spark search for regulatory framework Oliver Thew ryptocurrencies have undergone a supply, the name for its production – mining Chairman Larry Fink dismissed the market as an Ctransformation. They were originally – and strong performance over 2017, some ‘index of money laundering’. designed as simple tokens for making have even described bitcoin as the ‘new gold’. At the core of these rebukes is the idea financial settlements speedier and more New Zealand’s finance regulator and that cryptocurrencies lack any intrinsic value. efficient. The aim was to incentivise users the Monetary Authority of Singapore, Fiat currencies are valuable because they are of nascent distributed ledger technology however, have both announced that they a medium of exchange and offer a (mostly) platforms to decentralise mechanisms for classify cryptocurrencies as securities. The stable store of value. Cryptocurrencies are anonymous peer-to-peer transactions that Canadian Securities Administrators likewise inherently volatile, as events this year plainly bypass the formal financial sector. says ICO tokens and coin offerings fall under show. Between 8-12 November the price But over the last year, they have grown the definition of a security. The more that of bitcoin fell to $5,857 from $7,458 before into a massive segment of the global financial regulators treat cryptocurrencies as an asset climbing again to $7,843 on 16 November. market, attracting attention from investors, class, the more clarity and certainty they will It can be argued, too, that cryptocurrencies banks, exchanges, regulators, central banks bring to the market. have no store of value mechanism since and governments. There are more than 1300 Another reason for the markedly increased they can be replicated infinitely, as the active private digital currencies, 542 of which investment in cryptocurrencies is the increasing number of ICOs illustrates. This were issued since the start of 2017, compared development of new products and investment suggests there is no limit to the creation of to just 100 issued in 2016. cryptocurrencies, meaning price discovery is In addition to the number of different a function of speculation and momentum. coins and volume of transactions, the value of The more that regulators ICOs have garnered increased criticism. cryptocurrencies has increased dramatically. treat cryptocurrencies as The most common is that the fund raising The value of bitcoin, the most famous method is unregulated and, in some instances, cryptocurrency, rose to more than $10,000 per an asset class, the more clarity potentially fraudulent. Regulators in the UK, unit on 29 November from $960 on 1 January. and certainty they will bring to Europe, Australia and the US are among those The market capitalisation of all cryptocurrencies the market. to have issued warnings in 2017. The Financial exceeded $330bn at the end of November, “ Services Regulatory Authority of Abu Dhabi from $17.7bn at the start of 2017. released cryptocurrency guidelines, and ICOs Start-ups and new cryptocurrencies vehicles. This includes an increasing number of have been banned in South Korea and China. businesses have used initial coin offerings, contracts for difference, which allow investors Restrictive policies are being introduced for a relatively new digital fund-raising method, and brokers to trade cryptocurrencies. other aspects of the cryptocurrency market. to raise billions of dollars, rather than relying In November, the Chicago Mercantile Global exchange volume for bitcoin dropped on venture capitalists or other investors. Exchange announced that cryptocurrencies in January after the People’s Bank of China In 2017 ICOs were responsible for raising should be classified as derivatives and issued guidance to domestic exchanges on $3.2bn, outweighing venture capital funding that it would be launching bitcoin futures. their regulatory and operational policies. threefold in total deal size. In addition, Grayscale, a digital currency This led to periods where withdrawals and The last 12 months have seen a surge of investment company, has established three margin trading were stalled, and charges were capital inflows from retail and institutional cryptocurrency-specific trusts that resemble instituted after years of no-fee trading. investors. Out of the total of 124 cryptocurrency exchange traded funds. In 2017, their value Despite these steps, the cryptocurrency hedge funds, more than 90 opened this has increased exponentially compared market is still condemned for lacking a robust year. In October, the first ever fund-of-funds to traditional markets, with the Bitcoin regulatory framework. Attempts to label for cryptocurrencies was established. And Investment Trust stock price rising to $960 in cryptocurrencies as an asset class have been although no sovereign or public pension funds November from $136 in January. pilloried on the grounds that the market is too have publicly announced investments into Product innovation, increased investment small compared to fixed income, derivatives cryptocurrencies, other institutional investors and efforts to classify cryptocurrencies have or stocks. Questions remain about the varying have established dedicated funds. prompted the development of a substantial levels of anonymity within different private trading infrastructure. There are more than digital currencies, given the strict know-your- Asset class definitions 100 cryptocurrency exchanges around the customer and anti-money laundering laws One key factor behind this boom is that world. Regulators in Japan approved 11 that apply to the financial services sector. investors, banks, other market participants new exchanges and Keith Noreika, acting US Nonetheless, the increase in regulation and regulators have started to define comptroller of the currency, has stated he is in 2017 will have a positive effect and help cryptocurrencies in terms of asset classes. considering imposing a nationwide licensing establish more credibility in cryptocurrencies. Despite the name, cryptocurrencies are programme for digital currency exchanges. This could help stabilise price volatility and lead rarely classified as currencies, and the task to more efficient price assessment processes. of asset class definition is typically left to the Regulatory credibility Such developments could, in turn, attract discretion of national regulator. Cryptocurrencies have been met with their institutional investors. In spite of occasional The US Commodity Futures Trading fair share of criticism. UBS analysts compared controversy, 2017 has without doubt been the Commission classifies bitcoin as a commodity, cryptocurrencies’ performance to the 17th year of the cryptocurrency. That trend looks as there will never be more than 21m bitcoins century Dutch ‘tulip bulb bubble’, business certain to continue. in existence. That figure is written into the magnate Warren Buffet said the idea that ▪ currency’s source code. Given its limited bitcoin has any value is a joke, and BlackRock Oliver Thew is Programmes Manager at OMFIF.

BTN_12.17_00i_focus COVER.indd 1 24/11/2017 13:01 Looking back over year of predictions: risks remain embers of the OMFIF advisory board highlighted political risk as a key concern in their predictions for 2017, published in the January edition of MThe Bulletin and reviewed here using a series of 'star ratings'. Risks remain, but ̶ fortunately ̶ many have not materialised. Military or economic conflict did not erupt between the US and China, and trade wars and accusations of currency manipulation were avoided. Yet a series of events that were not forecast, including the UK general election, the declaration of independence in Catalonia, and increased military tensions in the Korean peninsula, highlights the role of political events in driving markets during 2017. On a range of issues the Advisory Board predictions proved prescient. As Michael Stürmer anticipated, ‘Chancellor Angela Merkel’s Christian Democratic Union will come out on top in Germany’s election, but no one will be able to claim a real victory.’ The breakdown in coalition talks in late November exacerbates the challenges for European integration. Donald Trump is mired in hostility from his own party, as well as the media and the courts. As Reginald Dale surmised, ‘Congress will be more difficult than Trump expects. Public dissatisfaction will rise’. The result is a weakening of leaders in Europe, the UK and the US, lowering their ability – and in some cases willingness – to shape the global agenda. Meanwhile the 19th Communist party congress cemented Chinese President Xi Jinping’s authority. This could lead to a greater international role for China in political, economic and military terms. As Meghnad Desai predicted, China provided ‘a major driving force for the world economy’ in 2017, though it faces domestic challenges that Xi’s government may address with more vigour in coming years. The Federal Reserve looks set to raise rates for the third time this year in its December meeting, confirming Marsha Vande Berg’s prediction of a rate of 1.4%. Growth in Europe and Japan was stronger than most expected. In Latin America, Brazil showed a robust economic recovery throughout the year, as forecast by Otaviano Canuto. External demand was a significant factor behind this growth, with domestic reforms remaining incomplete. This raises vulnerability to factors beyond these countries’ control, including the pace of US interest rate rises and geopolitical tensions. Meanwhile, structural weaknesses in European banks, highlighted by Akinari Horii, and an excess of savings over investment in Japan, addressed by Jennifer Corbett, are continued sources of potential instability. The least successful predictions were those regarding financial market imbalances, epitomised by John Plender’s fear that ‘there will be a spike in bond market yields, and heightened volatility will disturb global markets.’ While vulnerability is on plentiful display, one of the most notable features of financial markets over the last 12 months has been the absence of marked volatility. Similarly, the ‘transition from monetary to fiscal stimulus’, highlighted by Colin Robertson, did not create market turbulence. A coup in Zimbabwe could herald a change in economic and political prospects for the country. However, uncertainty could add to demand for hard currency, putting downward pressure on bond notes introduced last year, as anticipated by Mthuli Ncube. India’s growth has moderated but remains robust, while low oil prices and poor economic diversification hampering Nigeria’s performance. Rising tension between Saudi Arabia and Iran has added to instability in the Middle East. Oil prices rose throughout the year, but commodity exporting currencies suffered from mixed results.

Prediction: ‘US interest rates will increase by an additional 75bps in 2017, to be spaced out in three hikes over the course of the year. The year will finish with a rate of 1.4%. Corporate tax relief and financial sector deregulation will provide fodder for continuing tightening.’ (Marsha Vande Berg) Outcome: The Federal Reserve raised interest rates to a range of 1-1.25% in two policy meetings during 2017, with a third rate rise of 25bps widely expected in December. That puts the prediction of 1.4% right in the centre range. The dollar weakened by 7.6% in real terms from the start of the year to September over the slow pace of fiscal expansion and political setbacks for Trump in the courts and in congress, before regaining some ground in October. This eased pressure on the Fed to tighten earlier, while the appointment of Jerome Powell as Fed chair, seen as a moderate candidate, reduces risk of more aggressive tightening.

‘Chancellor Angela Merkel’s Christian Democratic Union will come out on top in Germany’s election, but no one will be able to claim a real victory. The right-wing Alternative for Germany (AfD) will enter parliament, reducing the conservatives’ coalition leeway.’ (Michael Stürmer) Germany’s two leading parties – Merkel’s Christian Democratic Union-Christian Social Union pairing and the Social Democratic Party – achieved a combined vote share of 54% in September’s election – the lowest on record. The anti- euro AfD gained 13%, beating expectations and making it the third-largest party. Merkel’s political credibility suffered further setbacks when coalition talks broke down in late November. The chancellor seemed to favour new elections – which could have left Germany without a government until mid-2018 – before raising the prospect of a minority government. Attempts to form a wide coalition between the CDU-CSU and SPD have now become the main focus.

‘Geert Wilders’ Party for Freedom (PVV) will not become the largest party in the Dutch parliament, though his party will make gains. Mark Rutte will continue as prime minister and his party will be the winner of the elections. There will be a broad coalition of four, possibly five, parties in the next government.’ (Roel Janssen) Mark Rutte remains prime minister after his VVD party won the largest vote share, at over 21%, although his party lost eight seats. The populist PVV party came second, with 13% of the vote, giving them 20 seats – an increase of five. As anticipated, the PvdA was the worst performing party, losing 29 seats, while the Greens won the most, with 10 new seats. Talks to build a coalition government lasted almost seven months, the longest in Netherlands’ modern history. As expected, four parties participate in the new government, and the PVV is not represented.

II | FOCUS: 2017 IN REVIEW December | © 2017 ‘After two years of GDP contraction, rising unemployment and credit crunch, the Brazilian economy will stabilise in 2017. The political crisis has not impeded the economic reform agenda, and the central bank has hinted at lowering interest rates as inflation has receded.’ (Otaviano Canuto) Brazil emerged from its worst recession in recent history in the first quarter of 2017, with 4% annualised growth, boosted by strong agricultural exports. Favourable weather conditions and a weaker real played a role, but structural reform and improved external accounts were key factors. Industrial production and the services sector stabilised and began to strengthen, consumption increased and the Bovespa equity index reached record highs. Growth has been supported by falling inflation, which declined to 2.5% in September from 11% in 2016, leading to a series of interest rate cuts by the central bank.

‘Trump will make progress on deregulation and tax reform in 2017, but not as much as he would like on immigration and healthcare. Congress will be more difficult than he expects. Public dissatisfaction will rise.’ (Reginald Dale) In mid-November the House of Representatives passed Trump’s tax bill, which will now move on to the Senate. The Republicans’ margin in the upper chamber is much slimmer than in the lower, meaning the proposal may not secure the necessary votes, at least without amendment. Repealing regulations is notoriously complex and time-intensive, with little material progress so far. Difficulties in passing legislation has frustrated many of Trump’s supporters and encouraged Trump to issue a range of executive orders, many of which have seemed to confirm some of the worst fears of his opponents. His approval ratings reached among the lowest of any president.

‘The spectre of hyperinflation in Zimbabwe still looms, and the introduction of bond notes in late 2016 could make the situation worse. Given the demand for dollars in currency markets, the notes may begin to depreciate, forcing inflation upwards. The Zimbabwean authorities must watch out for this.’ (Mthuli Ncube) The national statistics agency of Zimbabwe puts the annual inflation figure at less than 0.8%. Inflation is significantly higher than official data suggest because these figures use hard currency prices, whereas electronic payments and newly introduced bond notes make up a significant amount of actual payments, and these have depreciated substantially against their official dollar exchange rate. Consumers and businesses report price rises of between 20%-50%. A military coup in mid-November is likely to lower confidence in government-sponsored bond notes increasing demand for hard currency, which could cause further depreciation, boosting annual price rises.

‘Both India and China are expected to perform strongly in 2017, providing a major driving force for the world economy. Each faces risks, however. Implementation of Modi’s reform agenda in India could encounter teething problems which disrupt economic activity. China faces high debts and a slowdown in the old economy.’ (Meghnad Desai) India’s growth rate has slowed in each of the last four quarters, mainly due to two short shocks. Demonetisation in late 2016 affected economic activity in the informal sector. The introduction of the simplified Goods and Services Tax was beset by complexity from politically-inspired exemptions, increasing the burden on businesses. Despite this, growth remains healthy at 5.7% and, with inflation below the 5% target, the central bank could ease policy. Chinese growth remained strong ahead of the Communist party congress, following which a greater emphasis on rebalancing towards consumption and reducing debt was earmarked by the authorities.

‘The regime in Syria will have significant success in the civil war and Aleppo will be totally in government hands. The downside is that Trump will cause real problems with Iran. He will not renege on the nuclear deal, but increased US pressure will create domestic problems for President Hassan Rouhani, who faces election in May.’ (Boyd McCleary) IS has been pushed back from much of the territory it held in Syria and Iraq. Raqqa, the capital of IS, was retaken in late 2017. Aleppo remains in government hands. As predicted, Trump has increased pressure on Iran, though he went further than anticipated by refusing to certify that Iran is meeting the terms of the nuclear deal. Increasing hostility from the US as well as Saudi Arabia has strengthened hard-line elements in Iran. Although Rouhani won a strong victory in May elections campaigning as a reformer, external opposition has boosted support for a more autarkic and conservative outlook.

‘Structural reform in Japan will make progress in 2017, but by its nature the effects will only be felt with a lag. Nevertheless, Japan may surprise with stronger growth than anticipated, partly because domestic austerity has been abandoned and partly because the US will grow more strongly under Trump.’ (Jennifer Corbett) Japan grew at an annual pace of 1.4% in the third quarter of 2017, the seventh consecutive quarter of growth. Unemployment is at a two-decade low and some wages are rising to attract workers. Nevertheless, much of Japan’s expansion was driven by external rather than domestic factors, questioning the effectiveness of Prime Minister Shinzo Abe’s efforts at boosting the economy. Household consumption and public investment both subtracted from third quarter growth, and business investment provided only a minor contribution. Exports were the main factor, with a weaker yen reducing imports and boosting foreign sales, adding two percentage points to growth.

December | © 2017 FOCUS: 2017 IN REVIEW | III ‘European banking instability will be the most significant downside risk for the global economy in 2017. This is an election year for important EU countries and the problem is likely to get worse before the required public support is given to any plan of fundamental reform. Rising populism would make this process thornier.’ (Akinari Horii) Long-term weaknesses in Spanish and Italian banks came to the fore in June, with the dismantling of Banca Popolare di Vicenza and Veneto Banca, the rescue of Monte dei Paschi di Siena, and the resolution of Banco Popular, Spain’s sixth largest bank. The orderly handling of these events prevented instability from spreading to the European banking sector as a whole, but there are significant concerns over whether future crises could be resolved as quickly. These events tested the euro area’s new Single Resolution Board for dealing with failing banks. The uneven application of SRB rules to failing banks raises questions over its effectiveness in the event of an emergency.

‘Nigeria’s economic fortunes are unlikely to improve significantly in 2017. The solution to the country’s challenges lies in fundamental policy adjustments, which the government is unwilling to make. The central bank’s misaligned policy of seeking to maintain an artificial exchange rate for the naira is adding to challenges.’ (Kingsley Moghalu) After contracting by more than 1.6% in 2016, the IMF forecasts the Nigerian economy to grow 0.8% in 2017. The economy is around $175bn smaller than 2014, before the collapse in oil prices. Oil prices are rising owing to an agreement between the Organisation of the Petroleum Exporting Countries and non-Opec states, which Nigeria is not participating in. Increased output in 2017 means government revenues are growing. However, reforms to diversify the economy and boost manufacturing and services have stalled. The central bank exchange rate targeting programme remains in place, albeit in relaxed form, making foreign currency scarce for manufacturers and importers.

‘The European Central Bank will be challenged by low inflation, sluggish growth and political uncertainty. Throughout 2017 policy will remain expansive and, following adjustments to the purchase programme rules, the topic of a possible shortage of bonds to buy will not play a role in 2017, as it did in 2016.’ (Stefan Bielmeier) Inflation in the euro area fell to 1.4% in October from a high of 2% in February, while weak nominal wage growth has weighed on consumption. However, growth was stronger than anticipated, with expansion of 2.5%, the highest since the 2011 debt crisis. Unemployment, at 8.9%, is at its lowest level since January 2009. Citing the need to support higher inflation in the medium term, the ECB announced continuation of bond purchases, at a decreased rate of €30bn per month, from January 2018 until at least September. The topic of bond shortages did not play an explicit role in the ECB’s decision to reduce purchases, however it did lower the Bundesbank’s purchases from April onwards.

‘One could imagine a rapprochement where the US agrees that Russia should control its part of the world, and in return Russia agrees no longer to contest the enlargement of the North Atlantic Treaty Organisation and the EU. But this would be a fool’s peace, and could open the door for further Russian meddling in the West.’ (John Kornblum) Trump’s rhetoric towards Moscow has largely been informed by having to deny improper meetings between his team and Russia before and during the election campaign. This has prevented Trump becoming too close to Putin. Investigations have led to the resignation of Trump’s national security adviser and former campaign manager, with more possibly to come. Nevertheless, in November both leaders had several informal discussions and Trump told reporters that he believed Putin’s assertion that Russia did not meddle in the US elections. Other areas of agreement include the pledge of both countries to keep fighting IS in Syria. Broader reconciliation has, however, not materialised.

‘Marine Le Pen will not become French president. The informed money stays on François Fillon, leader of the mainstream conservatives, who will take traditional conservative-catholic votes away from her. However, a surprise cannot be totally excluded.’ (Jacques Lafitte) President Emmanuel Macron’s La République En Marche! political party was founded in April 2016. He was elected in May at the age of just 39 with 66% of the second-round vote, and REM went on to win an absolute majority in the French assembly. Fillon’s Republican party has 112 seats and Le Pen’s National Front has eight. This gives Macron a significant mandate for reform, a factor which contributed to some of the most important unions not participating in a general strike against policies to liberalise labour markets. Opposition from the socialist France Unbowed party is vocal but, with 17 seats, has little influence at the assembly.

‘The greatest risk for financial markets in 2017 is the transition from monetary to fiscal stimulus. This is not typically kind to bond markets, especially when yields are exceptionally low. Higher bond yields could harm equities by raising the cost of share buy-backs.’ (Colin Robertson) Monetary policy remains loose across the major economies, albeit in reduced form, reflecting a still-weak recovery and low wage inflation despite falling unemployment. Unwinding the Fed’s $4.5tn balance sheet will be a gradual process. The ECB remains committed to €30bn of bond purchases a month and the Bank of Japan will continue its monetary expansion. At the same time fiscal policy has been loosened in many economies, adding to concerns over rising debt. It is also occurring relatively late in the global recovery, potentially adding to instability. Overvalued financial assets and a lack of central bank manoeuvrability in the face of a future crisis remain key financial risks.

IV | FOCUS: 2017 IN REVIEW December | © 2017 Fundamentals for many emerging market economies look sound and prices of many commodities have either stabilised or are rising. This should provide support for the currencies of commodity-producing nations. An emerging market currency rally in the beginning of 2017 may not last the entire year.’ (Gary Smith) The Mexican peso was among the best performing emerging market currencies in the year to September, rising more than 17% in real terms against a basket of 61 currencies. The Philippines saw one of the largest falls, of over 6%, while Saudi Arabia, Russia, Brazil and Indonesia declined by 4%-6%. After September a number of currencies fell on the expectation that the Federal Reserve would raise rates again before the end of the year. Strong economic growth in emerging markets generally and rising oil prices have supported some currencies. However, emerging market currencies faced large sell-offs towards the end of the year, reflecting concerns over high indebtedness and other factors.

‘The greatest threat in both economic and geopolitical terms is Donald Trump. Market observers expect a combination of loose fiscal and tight monetary policy, but the Fed may tighten more in response to inflationary pressure than markets expect. There will be a spike in bond market yields, and heightened volatility will disturb global markets.’ (John Plender) One of the notable features of financial markets during 2017 has been the lack of volatility in spite of the continued build-up of risks and imbalances. Although the US has raised interest rates to between 1%-1.25% so far (most likely rising to 1.25%-1.5% in December) and committed to gradual balance sheet reduction, this has barely affected markets. This reflects effective signalling and strong global economic growth, as well as continued stimulus in other key economies including Europe and Japan. However, there is a sense that markets are not adequately accounting for sizeable risks including domestic political uncertainty in the US, tensions in the Middle East and Asia, and high global debt levels.

‘The Chinese economy faces slower growth, capital outflows and external headwinds, particularly from potential US trade tariffs. Retaliation could be sought by a large devaluation, but that would risk the implosion of China’s corporate and bank balance sheets that are most exposed to dollar debt.’ (Neil Williams) Economic stability in 2017 was a foregone conclusion ahead of China’s quinquennial Communist party congress, in October. Official GDP figures show expansion of 6.8% in the third quarter of 2017, while capital outflows for the year to date have reduced substantially. This has been supported by restrictions on Chinese outward investment, appreciation of the renminbi and significant strengthening of corporate balance sheets in 2016, which had accounted for a large share of capital outflows last year. US firms signed deals worth more than $250bn with China during Trump’s trip to Asia (although most of these are non-binding memoranda of understanding, and some may have already been announced).

‘This year will continue to see low oil prices, confirming that the current downturn is structural rather thana temporary cyclical shift. Demand growth worldwide is still being outstripped by production, and Opec does not seem strong enough to make the necessary dramatic cuts to raise prices.’ (Nick Butler) Production cuts of up to 1.8m barrels per days agreed between 21 Opec and non-Opec countries helped to push oil prices to over $64 per barrel in November, from $54 in January. Opec surpassed expectations of cohesion despite a significant diplomatic rift among Gulf countries. However, this was not uniform among the Opec countries, with non- Opec states including Russia, Sudan and Mexico responsible for much of the combined production cut. The extent of future rises is limited by a structural shift in oil markets created by US shale producers. The International Energy Agency expects the US to account for 80% of the increase in global oil supply between 2010-25, equivalent to 8m b/d.

‘Trump’s spending and tax promises will widen the budget deficit and cause America’s trade deficit to balloon. Trump will undoubtedly point an accusatory finger at China. A trade war between the world’s top two economies in increasingly probable.’ (Steve Hanke) The federal government budget deficit grew by $82bn to $668bn in fiscal year 2017. While Trump’s tax reform still has to pass congress, the difficulty of securing reductions in mandatory spending, which makes up the majority of federal outlays and requires the agreement of congress to amend, means any eventual tax cut is likely to widen the deficit. The trade deficit in the year to September increased by almost $35bn, or more than 9%, from a year before. Rather than single out China, Trump’s response has been to reject the rules-based international order in general, threatening to resort to using national legislation to open investigations into trade partners it accuses of unfair practice.

The greatest global geopolitical risk for the next five years is an armed conflict between the US and China, with India playing on the side of the US. Trump’s opening up to Taiwan shows his determination to irritate China one way or another. There is also potential for a Japan-China conflict.’ (Meghnad Desai) The US and China appeared to grow closer in 2017, culminating in Trump praising both China and President Xi on his 12-day tour of Asia in November. Sources of disagreement, including US labelling of China as a currency manipulator and holding it responsible for the large US trade deficit, have faded. Trump ‘doesn’t blame’ China, instead heaping condemnation on US policy-makers. The biggest flare-up has been in North Korea, where Trump seems to accept a trade-off with China in order to gain its support for increased sanctions. China understands well this national interest in international affairs. This could reduce antagonism between the two countries.

December | © 2017 FOCUS: 2017 IN REVIEW | V Shortcomings in global leadership China moves into vacuum left by US shift to unilateralism hortcomings in global leadership proved to be a major source of concern in 2017, opening the way for growing competition for influence Samong emerging powers, particularly in Asia. Chinese President Xi Jinping was quick to move into the vacuum left by the US shift to unilateralism under President Donald Trump. In contrast to the US, Xi is asking partner countries to take shared responsibility for global problems, a superficially beguiling multilateral approach. Trump’s withdrawal of the US from the 2015 Paris climate agreement signals rejection of this multilateralism by the world’s No. 1 economy (and second largest polluter). Similarly, withdrawal from the Trans-Pacific Partnership trade deal cedes US leadership over intellectual property protection, improved competition rules for state-owned enterprises and enhanced labour and environmental standards – all of which could have helped US exports – in the Asia Pacific region. However, towards the end of the year there were signs of rapprochement between Trump and Xi, above all because of the need to find common policies to tackle the threat of conflict with wayward nuclear-armed North Korea. On the European stage, UK Prime Minister Theresa May has been weakened by infighting in her Conservative party over the terms of Britain’s exit from the European Union. In the snap June general election, the party lost its parliamentary majority. This reduces the government’s ability to act boldly, whether on Europe or domestic issues – as illustrated by its highly defensive Budget in late November. A wide coalition seems the most probable outcome of Germany’s inconclusive elections, reducing the clout of Chancellor Angela Merkel and highlighting widening domestic divergence over controversial issues including immigrants’ rights and euro area integration. Meanwhile, an unwieldly coalition in Italy may return former Prime Minister Silvio Berlusconi to government, with the eurosceptic Five Star Movement, which is on track to be the largest single party, as the main opposition. Latin America has faced its own leadership problems. Brazilian President Michel Temer survived a vote in congress on whether he should face trial for allegations of corruption, although almost half of the votes cast went against him. The vote occurred barely a year after his predecessor, Dilma Roussef, was impeached on corruption charges. Such instability at the top of government creates difficulties for the large- scale reform package which the country needs to enact, particularly regarding labour and pension laws. Mauricio Macri, Argentina’s president, exhibits the enhanced appeal of anti-establishment parties. The overthrow of Zimbabwe’s long-time President Robert Mugabe highlighted the dangers which the lack of a clear succession plan can present in countries ruled by strength and personal connections rather than democratic norms. The transition in South Africa, inwhich President Jacob Zuma is seeking to have his ex-wife succeed him (with parallels to Mugabe) – in part to shield him from prosecution – will add to regional uncertainty. Vladimir Putin of Russia faces elections in March which may secure him another six years as president until 2024. The absence of a significant opposition party or credible candidate means his victory is almost assured. However, the absence of an alternative to Putin and the lack of a successor from within his own party adds fragility to the system. These fluctuating political circumstances – in contrast to a marked lack of volatility on financial markets – are unlikely to yield the leadership necessary to tackle the global economy’s challenges, from reining in under-regulated financial centres and taking thoroughgoing action on climate change to reforming euro area governance.

OTAVIANO CANUTO US withdraws from Paris climate agreement

The US accounts for one-fifth of global carbon emissions, trailing only China. President Donald Trump’s announcement in June that he would withdraw the US from the 2015 Paris climate agreement undercut collective efforts to lower carbon output and transition to renewable energy sources. The move jeopardises the US pledge of $3bn to the United Nations- backed Green Climate Fund, created to transfer capital from rich to developing countries to help mitigate and adapt to the effects of climate change. Regardless, 34 US states have undertaken their own ambitious carbon reduction plans – a marker for future administrations.

DENIS MACSHANE UK triggers Article 50 of the Lisbon treaty

After almost 25 years of mounting euroscepticism following Britain’s forced withdrawal from the exchange rate mechanism, the anti-Europeans secured victory in the referendum to leave the European Union. Prime Minister Theresa May’s Article 50 letter from March set the process in motion, but no one knows how it will end. Policy-makers should see Brexit in the plural, not the singular. It is possible to leave the EU treaty, restore supremacy of law-making to the House of Commons, but remain a trading partner on the same terms as today. Quitting the single market and customs union would be an ideological step too far.

2017 was the year of the anti-establishment politician, riding sentiment, not ideology. Whatever one may think of Donald Trump, he has eschewed any semblance of ‘business as usual’. And then look at Emmanuel Macron’s victory in France. His party, barely months old at the time of the presidential election, came from nowhere to secure a strong majority in the national assembly. Latin America is two years into a similar brand of leadership. Mauricio Macri’s government in Argentina, which proved victorious in mid-term elections in October, demonstrates that the anti-establishment tide, based on a movement rather than a conventional political party, can be of lasting significance.

JOSÉ-MANUEL GONZÁLEZ-PÁRAMO Banking union: looking ahead and looking back

European banking union was launched in 2014. However, not the single rulebook nor the supervision nor the resolution framework are ‘truly single’ among member states, since different solutions have been implemented for troubled banks. The handling of cases over the last 12 months in Spain and Italy shows that bank failures in Europe are still not treated homogeneously. The resolution framework must eliminate loopholes that are contrary to its spirit, to consolidate the idea that taxpayers should not bear the cost of a crisis. National insolvency regimes should be harmonised. This means, too, publishing clear guidelines on funding and liquidity provision.

STEFAN BIELMEIER Minority government may be only way forward

Chancellor Angela Merkel is the outright loser from failed coalition negotiations after parliamentary elections in September. Until it forms a stable government Germany will not have a clear political voice on the future of the EU. At present, consensus on Europe seems possible only in a minority government. On foreign policy, a government of this kind can set the tone together with the French President Emmanuel Macron. Economic and structural development in Germany and Europe would likewise be possible with a minority government in Germany, under a new style of policy-making.

ANTONIO ARMELLINI Risks of populism in Italy

Italy will go to the polls between March and May 2018 under a new electoral law that encourages fragmentation and will make a clear majority hard to achieve. Former Prime Minister Matteo Renzi has been weakened by a split in his Democratic Party. Silvio Berlusconi has patched up a centre-right coalition, but its members are divided on most issues, and it could easily disintegrate. The populist Five Star Movement (M5S) is likely to be the largest party, but refuses to join forces with others. Paralysis and new elections seem probable. One alternative may be a Renzi-Berlusconi ‘grand coalition’, the least expected, but possibly least dangerous, outcome.

REGINALD DALE Trump rejects Trans-Pacific trade deal

Donald Trump cancelled US participation in the Trans-Pacific Partnership on his first working day in the White House. He wanted to fulfil promises to oppose international trade deals he considers ‘unfair’. The rejection was condemned by those who considered the TPP a great opportunity to contain Chinese expansionism in Asia and ensure continued US predominance in an open world trade order. The move did not kill the TPP, as the 11 remaining countries resuscitated the pact in November. While it will bring them fewer benefits without the US, it should still be economically worthwhile – and show that US leadership is not essential.

Donald Trump’s nomination of Jerome Powell as Federal Reserve chair reflects his desire to remove Obama-era appointees from office. Powell will begin his term by presiding over rising interest rates and gradual normalisation of the balance sheet. He starts, too, when congress and regulators are weakening provisions of the Dodd-Frank Act. A tight labour market and probable passage of a non-revenue neutral tax act increase the odds of unanticipated inflation and a more rapid firming of US monetary policy. The scale of the Fed’s intervention in recent years may make a policy mistake more likely. If Powell pursues a monetary policy that Trump does not like, the president probably will not restrain himself from sending invective-filled tweets about the Fed.

MEGHNAD DESAI Why May is safe

UK Prime Minister Theresa May’s poor performance in the June general election eliminated her Conservative party’s parliamentary majority and revived the credibility of the opposition Labour party. The Conservatives know she is weak, but removing her would further divide and weaken the party. A new leader may feel compelled to call a general election. In any of these scenarios, the risk of losing power is too great for the Conservative party to try. This creates May’s paradox of ‘weakness as strength’. She has to be kept in office until the June 2022 due date of the next election, when there will be clarity over Brexit. Until then, May is safe.

VICKY PRYCE Paradise Papers reveal lack of reform

Revelations from the ‘Paradise Papers’, stemming from the leak of confidential documents from Bermuda-headquartered law firm Appleby, are raising controversy about potentially questionable dealings in offshore financial centres. They follow April 2016's equally revelatory 'Panama Papers', which uncovered what looked like massive tax evasion and money laundering. There are many legitimate reasons for the existence of offshore finance centres. But the mood is changing. The Organisation for Economic Co-operation and Development is overseeing the development of a common reporting standard. The latest revelations suggest change is overdue.

ALISHAN GEDIK Erdogan wins constitutional referendum in Turkey

Upward revisions of Turkey’s official GDP statistics partially mask the impact of geopolitical tensions, increasingly authoritarian domestic policy and deteriorating growth prospects. April’s constitutional referendum was intended to mitigate political uncertainty. However, the reinforcement of presidential power and the weakening of Turkey’s system of checks and balances could undermine foreign investor confidence. The referendum was seen by many as the ultimate test of President Recep Tayyip Erdogan’s popularity. The Yes camp argued a strong presidency would create a robust and stable Turkey, while the No side said the changes would give the office of the president too many powers. Erdogan could now stay in office until 2029.

Antonio Armellini is commissioner, Italian Institute for Africa and the Orient. Stefan Bielmeier is chief economist, DZ BANK. Otaviano Canuto is executive director, World Bank. Reginald Dale is Director, Transatlantic Media Network. Meghnad Desai is emeritus professor, London School of Economics and Political Science. Aslihan Gedik is deputy general manager of the OYAK Anker Bank. José Manuel González-Páramo is board member, BBVA. George Hoguet is chair of CFA Society Boston. Denis MacShane was UK minister for Europe. Vicky Pryce is chief economic adviser, Centre for Economics and Business Research. David Smith represented the UN Secretary-General in the Americas.

VIII | FOCUS: 2017 IN REVIEW December | © 2017 Getting the most out of green bonds Financing adaptation to climate change Joaquim Levy, World Bank Group he implications of climate change require The International Bank for Reconstruction bonds with high credit ratings, and because Tnew ways of mobilising finance to fund and Development was the first issuer of ‘plain there is often insufficient risk segregation mitigation and adaptation efforts. Green vanilla’ green bonds for mainstream investors between green and ordinary bonds at the bonds can play an important role, as they in 2008, after the European Investment Bank issuer level to point to different risk levels. raise resources from capital markets to fund distributed its structured note in 2007. This is the case even if resources from green climate-related activities by private and The IBRD is the largest non-European bonds are effectively applied in green projects. public actors. But getting the greatest benefit supranational issuer of green bonds. The Demonstrating that green bonds offer higher from green bonds, including in financing World Bank has supported corporates, banks risk-adjusted returns than ordinary bonds climate-smart infrastructure in developing and sovereign and sub-sovereign issuers, requires more empirical evidence and economies, requires addressing issues around including in new types of green bonds. This improved disclosure standards, including their economic foundations and pricing. year it has supported the first issuance of an integrated financial reports that more fully Green bonds are part of the emerging field Islamic green bond in Malaysia and the first reflect the overall balance sheet risk of issuers. of green finance, which is essential to achieving sovereign green bond from a developing A second reason for green bonds to the United Nations’ sustainable development economy, issued by Fiji. command a market premium occurs when goals for 2030. A large portion of this financing governments price perceived positive ought to come from the private sector, which Pricing green bonds externalities through policy action. This may is bolstering its efforts on environment-related Close to $140bn worth of green bonds will include tax advantages, minimum holding challenges. Asset managers, insurers and be issued in 2017, far above the previous requirements for institutional investors or pension funds have broadly adopted the UN- record set in 2015. However, they have been smaller write-downs when green bonds backed ‘principles for responsible investment’ the preserve of relatively short maturity and are discounted by the central bank in open and environmental, social and governance high seniority instruments. The market will market operations. criteria to help guide long-term investments. need to absorb longer maturities and more Such incentives help address asset diversity to play a greater role in climate and managers’ constraints, but raise concerns on development finance. the issuer side, requiring new certification While investors are The pricing of green bonds should better approaches. The current process, which is reflect whether these assets are less risky than voluntary and fragmented, would become now barred from asset other bonds. Green bonds were created in insufficient and could be open to abuse. This classes that do not observe response to demand for socially responsible is why some governments are moving to investment opportunities, as issuers sought define their own official standards for green sustainability principles, most to benefit from a demonstrable commitment bonds, and more international coordination cannot afford to pay a premium. to global sustainability. While many investors and technical assistance is necessary. “ are now barred from asset classes that do not observe sustainability principles, most cannot Opening the market In 2016 the private sector played a crucial yet afford to pay a premium when buying These considerations are crucial as green role in developing the recommendations green bonds. This is because they are bound by bonds’ maturity and diversification are from the Financial Stability Board’s task force fiduciary responsibilities focused on maximising extended to emerging markets and developing on climate-related financial disclosures. returns along traditional definitions. economies. The diversity brought by the Large investors have created initiatives such Fortunately, there is growing evidence Fiji bond is encouraging, with a seven-year as Climate Action 100+, which commits that securities that follow the principles for maturity and below investment-grade ratings. them to work with the companies they responsible investment are more valuable Climate-smart, resilient infrastructure invest in ‘to ensure that they are minimising than ordinary securities. This is easier to can produce long-term, low-correlation and and disclosing the risks and maximising the verify for stocks than for bonds, in part lower-risk cashflows. Capturing this value and opportunities presented by climate change because of the limited upside of bonds opening the market to socially responsible and climate policy.’ relative to stocks, the prevalence of green investors requires good practices in host countries and better information mechanisms. It may, too, require government pricing of the macroeconomic, environmental and developmental benefits of such projects, through blended finance and some de-risking. Multilateral financial institutions can help in both instances. They can likewise promote advances in more integrated corporate statements and the definition of green bonds. This will make it easier for investors to capture new opportunities, while fulfilling their fiduciary responsibilities. ▪ Joaquim Levy is Managing Director and Chief Financial Demonstrating that green bonds offer higher risk-adjusted returns requires more empirical evidence Officer of the World Bank Group.

December | ©2017 omfif.org SUSTAINABLE INVESTMENT | 15 New proposals on deposit insurance European scheme must heed risks of fragmented markets Stefan Bielmeier, DZ BANK he European Commission in October put banks’ existing non-performing loans and schemes which are dominated by a few Tforward new proposals for a European other problems before the transition to the big banks are more problematic. Although deposit insurance scheme. It hopes these coinsurance phase. In addition, during the the probability of a failure is lower in those measures, which are intended to take initial reinsurance phase, subsidiary support circumstances, if one out of a few big banks better account of risk imbalances between from the European deposit insurance scheme does fail this can lead to a large amount of national schemes, will go some way towards is only to be granted to overstrained national compensation for the insurance scheme. It is completing banking union in the region. schemes in the form of liquidity support therefore necessary to build up significantly The proposal modifies a draft document through loans. larger reserves. put forward at the end of 2015. According There are several prerequisites for a to this earlier proposal, a single deposit Non-performing loans viable and fair European deposit protection insurance scheme for the euro area would Compared to the 2015 version, the October scheme. The first is the systematic and gradually replace the existing system proposals offer an opportunity to reduce risk comprehensive elimination of banks’ existing of independent national schemes. The imbalances between the national protection NPLs. Second, a legal framework that allows Commission originally envisaged introducing schemes that result from NPLs. However, this a European ‘reinsurance’ phase by 2019. can be done if levels of acceptable risk are This was intended to syphon off some of not set too low and only if existing NPLs and The new proposals banks’ deposit insurance contributions for other troubles are systematically exposed offer an opportunity a new deposit protection fund. During the and eliminated. reinsurance phase, any depositor pay-outs The substantial differences between the to reduce risk imbalances were to be covered by the relevant national share of bad loans in banks’ overall exposure between the national schemes. Only if these were overstretched provides a rough impression of the extent protection schemes that would the new fund have intervened and of the problem. In some countries, such “ provided limited support. as Finland, Germany and the Netherlands, result from NPLs. The second phase, a European ‘coinsurance’ the NPL ratio is low, at 1.5%-2.5%. But it is scheme, was scheduled for 2020. The plan worryingly high in Ireland, Italy and Portugal, was to increase the share of contributions for at between 12%-17%, and still higher in Cyprus banks to enforce claims rapidly. Third, a the European scheme year-for-year. At the and Greece, where the ratio is 43%-46%. volume of contributions from the national same time, the national insurance schemes’ To the extent that banks’ existing NPLs are banking systems that accurately reflects the financial resources were to be increased to due to economic reasons, the bad banks, asset sector’s risk situation. 0.8% of the covered deposits. On transition securitisation and other measures, as well as A deposit protection scheme that fails to to the second phase the system was to be economic strengthening in Europe, are likely to meet these prerequisites brings the risk that converted from subsidiary compensation to improve the situation. The extreme differences depositor pay-out events occur repeatedly fixed quotas. The national protection schemes between the individual countries are, however, in countries with higher banking sector risk and the European scheme would have shared partly due to different legal conditions. This and that these pay-outs overstretch the the cost of any depositor pay-outs. involves bankruptcy law, rules regarding loan insurance reserves built up by the banks in foreclosure, and the length of the foreclosure the corresponding country. Europe’s banking procedure. In addition, there are major In such cases, banks would have recourse differences between banks’ lending cultures. to the deposit insurance reserves created systems are still largely by the institutions of the other countries. A fragmented into national sub- Fragmented European markets European deposit protection scheme that Europe’s banking systems are still fragmented fails to fulfil these conditions would lead markets with different risk into national sub-markets with different risk directly to a transfer union. conditions. This is reflected in conditions. This is reflected in loan interest The political focus should be on “ rates. This does not have to be negative as long implementing the measures of the last loan interest rates. as individual banks’ higher risk affinity remains comprehensive reform on national deposit limited and is priced into the loan interest rate schemes across all countries. If smaller According to the 2015 proposal the third in the form of risk premiums. But a higher countries in which a handful of banks stage would have come into effect in 2024. risk appetite affects the safety of customer dominate the market struggle to organise Deposit insurance in the euro area, including deposits. Logically, such banking systems a viable protection scheme, then several the collection of contributions and depositor should build up bigger deposit protection countries could form a single deposit compensation, would have been taken funds and collect higher contributions. protection scheme on a voluntary basis. over completely by the European deposit Another reason for having different But a compulsory single European deposit insurance scheme. minimum funding levels for the deposit insurance scheme must take account of It provided for an automatic transition to insurance funds lies in the structure of the the considerable risk emanating from still the next phase without any ‘emergency exit’, member banks. Deposit protection schemes largely fragmented national banking markets. for example in the event of risk imbalances are not insurance schemes in the legal sense, Anything else must be rejected. ▪ between participating countries. The revised but they function in a similar manner: the proposal put forward in October deals more banks with small risks participate, Stefan Bielmeier is Global Head of Research and with this by providing for an audit of the the easier it is to balance risks. But those Economics at DZ BANK.

16 | EUROPE omfif.org December | ©2017 ESM expands into dollar market Mitigating liquidity risk through investor diversification Kalin Anev Janse, European Stability Mechanism his autumn, the European Stability sovereign, supranational and agency issuers; The inaugural dollar deal, on 24 October, TMechanism turned five years old. This the first benchmark-sized deal with a negative attracted 130 investors assembling interest of coincided with the ESM’s debut bond deal in yield; and the first ultra-long benchmark-sized $7bn, with a significant number of new names. the dollar market, with which it raised $3bn. deal. In April, the ESM raised €8bn on a deal As the ESM had announced that it would not The ESM is a young institution, but a with an order book of €21.6bn. raise the intended volume, it sold no more mature capital market player. Together with But issuing only in euros exposes the than $3bn of this five-year bond. its temporary predecessor, the European ESM to risks. If the euro market ebbs, the Investor appetite for Europe has surged Financial Stability Facility, it is one of the largest ESM would lose its source of funding. While in 2017. With the US and UK facing political issuers of euro-denominated bonds. The EFSF/ taxpayers back the ESM’s credit, it does challenges, Europe has emerged as a safe ESM have more than €250bn in bonds and not use any taxpayer money to disburse haven. The economy is expanding sturdily, and bills outstanding. That is a striking figure for an assistance loans. All of its money must many non-European investors are interested organisation employing only 170 people. come from capital markets. As the lender in increasing their exposure to the region. The Among the landmarks, the EFSF/ESM have of last resort for euro area sovereigns, the ESM is the only blended euro credit available – accomplished: the largest order book among mechanism has no back-up. now also in dollars. The ESM is borrowing in the two strongest Inaugural dollar deal global currencies. More importantly, it has Investor appetite for The ESM began to address this funding achieved exceptional investor diversification liquidity risk in 2016. Its aim was to spread (see Chart). The euro will remain the ESM’s Europe has surged risk over the two deepest capital markets – main issuance currency while it continues in 2017. The economy is dollars and euros. to develop a strategic presence in the dollar expanding sturdily, and many The goal was to launch the first dollar deal market. The ESM is aiming to build a yield in October, around the time of the ESM’s fifth curve with maturities of two, three and five non-European investors are anniversary, to diversify the investor base years, and plans to go to market once or “ and capture cost efficiencies. It was decided twice per year. interested in increasing their to swap all of the proceeds back into euros, ▪ exposure to the region. as this is the only currency the ESM uses to Kalin Anev Janse is Secretary General of the European disburse loans to countries. Stability Mechanism.

Investor diversity in dollar v. euro issuance for European Stability Mechanism bonds $3bn bond, geographical breakdown €3bn bond, geographical breakdown

Middle East Asia and Africa 2% 2% Rest of Europe 9% Asia 11%

UK and Switzerland 34% Americas UK and Switzerland Euro area 31% 28% 61%

Rest of Europe 9% Euro area 13%

Source: European Stability Mechanism

December | ©2017 omfif.org EUROPE | 17 Aramco sale buttressing Saudi financial triad Riyadh’s steps to build ‘global investment powerhouse’ Elliot Hentov, Advisory Board t the Future Investment Initiative critical for Saudi Arabia’s equity and debt Aconference in Riyadh between October markets to expand and offer meaningful 24-26, investors focused on the potential financing alternatives. earnings of the planned privatisation of Saudi Second, the Tadawul, Saudi Arabia’s Arabia’s national oil company, Saudi Aramco. stock exchange, is moving into a phase of But they were missing the broader point. internationalisation and is on the cusp of Widely expected to be the largest initial multiple index inclusions. This has prompted public offering in history, the partial listing it to modernise rapidly in anticipation of of Aramco represents a unique opportunity increasing numbers of participants. Moreover, for Saudi Arabia to quicken the development a concurrent surge of privatisations could of its equity and bond markets. This will dramatically deepen the equity market. The optimise capital allocation to propel growth Aramco IPO is only the beginning of possible and help diversify the economy, as well as capital inflows, which could reach $140bn by complement social change in line with Vision the end of 2020 if Saudi Arabia fully embraces 2030, the country’s ambitious reform plan. market reform. Much of these inflows would One of the three pillars of this vision sets remain committed to the Saudi market out the aim to make Saudi Arabia a ‘global and thereby buttress the country’s foreign investment powerhouse’. While the country reserves in the medium term. has a strong legacy as a sovereign investor Third is the opportunity to include the in foreign markets, this ambition requires its Saudi people in the privatisation process. local financial system to deepen across all This could be achieved through a ‘national sectors. privatisation fund’. This would offer ownership of the privatised assets to Saudi Saudi Arabia’s triad of finance nationals at a discount, encouraging them There are several reasons why transforming to take a stake in the country’s future. The Tadawul is moving into a phase of internationalisation its financial markets matters to Saudi Arabia’s It would help set the foundations of a development. The first is to ensure sufficient retail investor class and symbolise a shift access to capital for businesses. A simple way in responsibility away from government General Organisation for Social Insurance – to think about financial systems is to consider policies to individual households. Fostering is the major investor in the domestic stock banks, equity and bond markets as a ‘triad’ such a retirement and savings culture would market. of finance. Strong economies tend to connect facilitate other reforms and complement The key point is that the components of savers with borrowers through a mixture of social change. the financial triad – banks, equity and bond these three channels. Fourth is the potential to build a domestic markets – are interdependent. Improvement Relying too much on one channel can lead bond market. Saudi Arabia runs a fiscal in the price discovery mechanism in one to a capital supply shortage if it becomes deficit, but this presents an opportunity segment refines pricing elsewhere until impaired. European businesses, for instance, to develop the local debt market as a third capital is optimally priced. Around 90% of have historically been overly reliant on bank financial pillar. For the sake of liquidity and Saudi businesses are small and medium- ease of access, the kingdom has issued sized enterprises, but these represent only dollar bonds to finance the large deficits of 2% of bank lending. If more firms could Future debt would 2016 and 2017. However, future debt would raise money through stock listings or debt be better issued in be better issued in riyal as part of a cohesive issuance, banks would be more likely to debt management strategy. This would increase their lending to worthy economic riyal as part of a cohesive anchor the construction of a sovereign yield participants. This in turn would promote debt management strategy. curve, which in turn would set a reference higher and broader economic growth. This would anchor the price for the local corporate debt market The Future Investment Initiative reaffirmes “ and aid the introduction of other financial Riyadh’s aspiration to become a more important construction of a sovereign instruments. financial centre. Given the momentum yield curve. behind its reforms and the potential scale of Realising Riyadh’s aspirations its domestic markets, this is a conceivable It is crucial that citizens are offered the goal. However, it cannot be achieved without finance. This precipitated marked difficulties chance to participate in the upside of any transforming the Saudi financial system to during the euro area crisis. Even companies economic reform. Apart from engaging offer better access to capital, in line with with strong balance sheets struggled to households in financial markets directly, Islamic values and social requirements. The access credit. this can be done through non-bank financial Aramco sale is an ideal opportunity to catalyse Saudi Arabia has a strong banking system, intermediaries that serve households. Two these developments. but bank liquidity moves procyclically in important types of such intermediaries ▪ line with oil prices. Liquidity falls during oil are private pension funds and insurers. Elliot Hentov is Head of Policy & Research in the Official downturns, just as other sectors retrench, Private pension funds in Saudi Arabia are Institutions Group at State Street Global Advisors, and a exacerbating economic slumps. It is therefore embryonic, but the main public fund – the Member of the OMFIF Advisory Board.

18 | EMERGING MARKETS omfif.org December | ©2017 Dealing with disappointment Quantitative easing and the rise of inequality Burcu Ünüvar, Industrial Development Bank of Turkey ceptics remain uncertain about whether could broadly be interpreted as a return to learn to navigate the consequences of the Scentral banks saved the global economy market fundamentals. tapering, which is likely to be gradual and after the 2008 financial crisis. Undeniably, well communicated. It will take some time however, monetary policy-makers helped Indirect consequences before central banks’ balance sheets shrink bolster business sentiment by flooding the Different economies are at various stages to pre-crisis levels, if they ever do. But there world with cheap money. Nearly 10 years of recovery. The fear is that tapering by are some indirect consequences of the on, there are confusing signals about the the leading central banks – while it might unconventional monetary policies which may future of monetary policy. Central banks’ move their economies towards ‘realisation’ not diminish or reverse. forward guidance appears to be exerting – could lead to negative repercussions on Although central bankers claim that diminishing influence. the aggregate economic benefits of their Attitudes towards central banks appear unconventional policies outweigh QE’s to be following a similar course to those Although central distributional effects, they must nonetheless towards new technologies: exaggeration address policy-induced inequality. This is not is followed by disappointment and, finally, bankers claim something that will improve gradually or understanding. Attitudes towards monetary that the benefits of their naturally as QE ends. policy appear to be reaching the end of unconventional policies Post-crisis asset price appreciation the ‘exaggeration’ phase, and risk creeping outpaced median wage growth, which is towards ‘disappointment’. outweigh QE’s distributional blamed as one of the key driving forces The separation principle in which “ behind the rise of anti-establishment political effects, they must address monetary policy targets price stability and parties in many developed countries. The regulatory policies target financial stability policy-induced inequality. shift towards political protectionism will not is no longer valid. The consensus about the necessarily subside in harmony with the ‘multi-tool, multi-objective’ approach to ending of QE. Policy-makers must be mindful central bank policy is well established. But other countries and push some markets, of both the accountable and unaccountable juggling multiple objectives inevitably puts especially emerging economies, into the impact of QE when they develop their central banks in a position of great power, ‘disappointment’ phase. tapering strategies. and loads expectations on policy-makers. Focusing only on the end of QE narrows ▪ policy-makers’ perspective on exit policies. Burcu Ünüvar is Head of the Economic Research Policy-induced inequality Asset markets in emerging economies will department at the Industrial Development Bank of Turkey. Central bankers, international financial institutions and market participants overestimated the power of unconventional Stock prices have generally grown faster than median income policy and underestimated the extent of Annual growth in index value, % the fundamental problems in the world economy. Comparatively little is known 25 about quantitative easing, as this is the first time it has been implemented on such 20 a large scale. Results which do not meet elevated 15 expectations risk introducing the ‘disappointment’ phase of the new monetary 10 policy perception. The prolonged period of abundant global liquidity boosted asset 5 prices, creating a feeling of comfort which transformed into a state of ‘reform fatigue’. 0 In economies where QE was pursued, it was generally observed that it is not a -5 monetary cure-all. As structural weakness started to weigh on the economy, it became -10 clear that people had not benefited equally from these unorthodox policies. This policy- -15 induced inequality – a strong reason for overall disappointment over QE’s effects – -20 will need to be considered in the measures which central bankers will introduce in the 2011 2012 2013 2014 2015 2016 period ahead. FTSE 100 Euronext 100 EU median income Dealing successfully with this disappointment will be crucial for markets to move to the ‘realisation’ phase, which Source: FTSE, Euronext, Eurostat, OMFIF Analysis

December | ©2017 omfif.org EMERGING MARKETS | 19 A new phase of trade expansion China initiatives raise confidence in international co-operation Otaviano Canuto, Advisory Council echnological advances and the removal sophisticated services. This partial reversal In 2013 Chinese President Xi Jinping Tof trade barriers have generated of offshoring and weaker demand for the announced the Belt and Road plan, China’s sustained trade expansion over the last typical exports of emerging markets will have international infrastructure initiative. three decades. The falling cost of shipping a marked impact on these economies. Investments through the Belt and Road, and of managing complex production China is rebalancing its economy away as well as the acquisition of foreign assets networks has accelerated fragmentation of from exports and towards domestic around the world, appears to be a way for manufacturing within global value chains. consumption. At the same time the country China to diversify partially its large foreign Companies have harnessed technology to is shifting involvement in global value chains exchange reserves out of low interest-bearing bring into cross-border manufacturing large government bonds. numbers of lower-wage workers in Asia and The Belt and Road will open new markets eastern Europe. The new proposals for Chinese companies, especially for the Countries linked by these global value offer an opportunity country’s vast excess capacity in cement, steel chains have transformed their economic and other metals. In addition to connections structures and achieved substantial increases to reduce risk imbalances throughout Asia, Africa and Europe, Xi has in total factor productivity. Expanded foreign between the national offered Latin American countries access to the trade has driven these economies’ transition Belt and Road. The Regional Comprehensive from low-value, low-productivity activities protection schemes that Economic Partnership, a proposed China-led towards production of modern tradable “ result from NPLs. free trade agreement, will likewise solidify goods, with China a special case in speed and regional networks. magnitude. There are signs, however, that these so that it can develop more value-added Parallel globalisation developments have reached a plateau. The functions. If China discards more low-skill, Barack Obama, as US president up to the elasticity of global trade relative to global GDP labour-intensive manufacturing activities, beginning of 2017, deliberately promoted has diminished by more than predicted by opportunities may increase for countries the adoption of ambitious multilateral analysis of post-financial crisis trade-damping with cheap and abundant labour. China’s agreements – dealing with goods and services factors. Prevailing advanced manufacturing transition has been taking place from a trade, investment and intellectual property technology may not be conducive to further starting point of low consumption ratios, low rights – like the Trans-Pacific Partnership fragmentation of production processes. wages, low levels of public social spending and Transatlantic Trade and Investment The scope for export-led hyper-growth has and high household savings. The rebalancing Partnership. By sidelining China from both, narrowed, not least because, in a more process is proceeding slowly, for fear that the US intended to pressure Beijing into risk-averse climate, importing countries are domestic growth rates might fall significantly. adapting Chinese policy in line with a new no longer able to run large current account Governments and central banks around international regulatory framework. In spite deficits on a pre-crisis levels. the world adopted countercyclical policies of President Donald Trump’s rebuttal of the to ward of economic collapse after the TPP, the 11 remaining countries involved Chinese rebalancing 2008 crisis. In China, quantitative easing agreed in November to the central elements Changes in aggregate demand in advanced generated increased shadow banking of a new and still far-reaching agreement. economies point to the growing importance activities and capital expenditure on housing Meanwhile, the Belt and Road is likely of local availability of goods and services and infrastructure, with state-owned to stimulate a new wave of Chinese exports compared with lower labour costs. The enterprises playing a key role. Overcapacity and investments. Improved infrastructure customisation of products is making proximity in some sectors and reliance on high debt networks in connected counties, most of to markets more relevant than low production levels have been used to meet official them emerging markets, will strengthen costs. Domestic consumption in advanced growth targets. Beijing has announced its trade integration. Prerequisites in terms of economies reflects the ‘dematerialisation’ intent to inhibit such measures before they policy and regulatory harmonisation would of products – fewer materials are used to can develop into more material risks to the not be as high as the ones embedded in the deliver goods – and increasing demand for domestic economy. TPP or TTIP. Both globalisation processes will evolve in parallel, and might even reinforce each other. Much will depend on the extent to which anti-globalisation sentiment rises or falls in key markets. Progress on trade deals like the new TPP and the wide reach of the Belt and Road should engender some confidence that international economic co- operation has not reached a nadir under President Trump – but can strike out in new and positive directions. ▪ Otaviano Canuto is an Executive Director of the World High-flying China: the Belt and Road initiative is likely to stimulate a new wave of Chinese exports. Bank and a Member of the OMFIF Advisory Council.

20 | INTERNATIONAL TRADE POLICY omfif.org December | ©2017 Perils of regulatory change Small states losing access to trade finance Jodie Keane, Commonwealth Secretariat egulatory changes intended to rectify average. The loss of correspondent banking often depend on the rating of local banks in Rthe ramifications of the 2008 financial relationships and increased challenges to relation to international financial institutions crisis are compounding the structural and securing trade finance are creating additional and the global financial system. The removal institutional capacity constraints small states obstacles to growth. of correspondent services from banks in face over trade. De-risking has reduced the Between September-December 2015, purportedly high-risk jurisdictions, although availability of trade finance because of the the Commonwealth Secretariat conducted they may be compliant with regulatory loss of correspondent banking. a survey on de-risking among its members. At the Commonwealth heads of government It showed a worrying rise in correspondent meeting in 2013, against the background of banking relationship closures, which have a faltering global economy, members of the doubled since 2013. This is having a marked A fast-evolving Commonwealth Secretariat called for efforts impact on regions such as the Caribbean. to boost trade finance facilities. Two years Seven of Belize’s nine banks lost their regulatory environment later in Malta, they secured support for a correspondent banking relationships. The is emerging and continues to ‘small states trade finance facility’. country’s central bank likewise lost one of its see ‘blacklisting exercises’ The loss of corresponding banking relationships. Of the states surveyed, 18 of relationships and potential effects on 24 feel they comply with the requirements, being used as a means of trade finance are a major concern for the and yet they have been penalised since “ enforcing new global norms. Secretariat. These factors are especially larger financial institutions believe these relevant for small states, which comprise economies are not worth the risk. 31 of the Commonwealth’s 52 member countries. Changing regulatory standards requirements, can adversely affect these In surveys undertaken by the International states’ ability to trade. This obstructs the only Closing corresponding banking relationships Finance Corporation, respondents most proven route for countries to lift themselves While much attention has focused on the frequently raised difficulties relating to out of poverty. implications of anti-money laundering and compliance requirements imposed by national Conventional business models are under countervailing terrorism regulations, the regulators and cross-border correspondent severe pressure in many small Commonwealth combined impact of post-crisis regulatory banks. Banks in countries across a broad jurisdictions. The factors behind this changes is squeezing corresponding banking range of regions, sizes, and income levels withdrawal are numerous and complex. The relationships. Invariably, the smallest and expect their costs to more than double this international dialogue has emphasised the poorest countries are disproportionately year. This will invariably impact the services need for affected jurisdictions to implement affected. these institutions can provide, including those global regulatory standards. Reflecting on the Small states depend more on trade where marginal costs may be high. role that jurisdictional reputation may play on than others for growth, but face far higher Small and medium-sized firms in poor the withdrawal of these banking relationships, trade costs than the developing country countries rely on credit applications, which an International Monetary Fund report called on states hosting offshore financial centres to reconsider the sustainability of opaque business models. In a fast-evolving regulatory environment, ‘blacklisting exercises’ are being used as a means of enforcing new global norms. This poses immediate challenges to jurisdictions as they try to adhere to rapidly evolving standards. The international tax transparency agenda will continue to impact the role played by international financial centres located in small states. But the broader tax avoidance agenda, which has focused on curbing the shift of multinationals’ profits to low-or no-tax jurisdictions, will clearly affect the role that some centres have played in the fragmentation of global value chains. Limiting small states’ access to trade finance will reduce still further their inability to tap into these value chains. ▪ Jodie Keane is Economic Adviser in the Commonwealth Secretariat. The views expressed are those of the author Belize: The removal of correspondent services from banks can adversely affect these states’ ability to trade and not the Secretariat.

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SDiS Advert new.indd 1 27/11/2017 14:49 Beyond the theatrical skirmishing Rational case for UK departure from European Union David Marsh rotagonists in the process of Britain with the EU is not a priority for the two-year Pleaving the European Union display a window up to March 2019. ‘Unless the EU wide gap in their psychological campaigning. sees that we are prepared not to sign a free The departing Britons must necessarily trade agreement, we will only be offered broadcast optimism about the future, play a bad one.’ The contingency of reverting to down possible hardships, and give as little World Trade Organisation rules would be an as possible away in assistance, money or acceptable option, the authors say. comfort to their adversaries. They point out that the WTO provides The remaining 27 EU members have the framework (buttressed often by sectoral a natural opposing interest in preserving regulatory accords) for present EU and UK intactness, creating solidarity and conserving trade with over 100 countries with which the funding, pride and the moral high ground. EU28 has not signed a free trade agreement, Across this emotionally complex terrain, including the US, China, India, Brazil and none of the participants can act or speak Singapore. The WTO likewise provides with totally honesty – setting the tone for the flexibility for the UK to fix sectoral import tariffs first 18 months of theatrical skirmishing over at zero if it wished. Prospects for a post-Brexit the terms of the post-June 2016 referendum EU-UK automotive sector deal are brightened divorce. In this fraught environment, there by EU car exporters’ fears that their UK sales is ample need for a book that sets out could fall if Britain adopts a zero-tariff option constructively and dispassionately the on auto imports – which would considerably economic case for why Britain’s EU departure cheapen non-EU countries’ exports. market which they rightly call an ‘economic may turn out to be a success. Clean Brexit – The authors apply similar thinking to a and social disaster’. Why leaving the EU still makes sense, goes a range of other areas. On the future of the Within the chosen field of economic, long way to meeting this requirement. City of London, they point out that vaunted industrial and social affairs, the holistic sweep of The authors, both economists – Liam ‘passporting’ is a relatively new phenomenon the book is an appealing feature. Better editing Halligan, best known for his Sunday Telegraph would have beneficially reduced the length columns, and Gerard Lyons, for many years and avoided unnecessary repetition. And for at Standard Chartered before he worked for The authors set out authors who espouse a British approach, it Boris Johnson as mayor of London – are both why agreeing a free is odd that they favour the American use of Leavers from the rational rather than rabid trade agreement with the ‘likely’ as an adverb meaning ‘probably’. camp. For this reviewer who voted Remain, More cogently, Halligan and Lyons lay largely because he thought (possibly naively) EU is not a priority. The out their wares at the beginning with pithy the UK could best reform the EU from inside, contingency of reverting summaries of recommendations – extending the analysis is persuasive. “ from digitalisation through to infrastructure to WTO rules would be an and a ‘Bismarckian approach to welfare’. Avoid arduous compromises acceptable option. There is a certain breathlessness about The book argues for a clean break, involving the relentless optimism, for example, over withdrawal from the single market and the prospects for a frictionless border customs union, with a two-year transition dating from 2007 that could be replaced in between Northern Ireland and the Republic period. Halligan and Lyons say this would be many cases by regularity ‘equivalence’. of Ireland, where the authors appear to rely a much better and less messy outcome – for On immigration, they see the need for a a little too much on ‘customs pre-clearance both the UK and the EU – than attempting constant net inflow of migrants, regulated and information-sharing.’ arduous compromises on combining the through a work permit system adapted for The book deserves to be read by people British desire to leave with the EU’s ‘four specific regions using biometric identity on both sides of the debate – including those freedoms’ of movement of goods, services, cards. They identify a lack of affordable in the rest of Europe who have made up their capital and people. housing and worries over student debt as far minds that Brexit is inevitably a bad thing. It The authors set out why agreeing a ‘bold greater problems than Brexit for most young might make them think again. and ambitious’ (in the words of British Prime people. They put forward a range of solutions ▪ Minister Theresa May) free trade agreement for repairing Britain’s ‘broken’ housing David Marsh is Managing Director of OMFIF.

December | ©2017 omfif.org BOOK REVIEW | 23 COUNCIL Meghnad Desai, House of Lords; chairman, OMFIF Advisers Johannes Witteveen, honorary chairman, OMFIF Advisers Philip Middleton, EY Louis de Montpellier, State Street Global Advisors Frank Scheidig, DZ BANK Songzuo Xiang, Renmin University of China Otaviano Canuto, World Bank Group Aslihan Gedik, OYAK Anker Bank Robert Johnson, Institute for New Economic Thinking William Keegan, The Observer John Kornblum, Noerr Norman Lamont, House of Lords Kingsley Moghalu, Tufts University Fabrizio Saccomanni, LUISS University Gary Smith, Barings Niels Thygesen, University of Copenhagen Ted Truman, Peterson Institute for International Economics Marsha Vande Berg, Stanford University Ben Shenglin, Renmin University ETS MARK CAPITAL MARKETS TAL API John Adams, China Financial Services C Yaseen Anwar, Industrial & Commercial Bank of China Irena Asmundson, California Department of Finance Georgina Baker, International Finance Corporation Stefan Bielmeier, DZ BANK Hans Blommestein, Vivid Economics Mark Burgess, Jamieson Coote Bonds Hon Cheung, State Street Global Advisors Michael Cole-Fontayn, BNY Mellon Thomas Finke, Barings Christian Gärtner, DZ BANK Trevor Greetham, Royal London Asset Management Gao Haihong, Institute of World Economics and Politics Daniel Hanna, Standard Chartered Bank George Hoguet, CFA Research Foundation IND Soh Kian Tiong, DBS Bank UST Group of Thirty RY Stuart Mackintosh, & IN Paul Newton, London & Oxford Capital Markets VEST Saker Nusseibeh, Hermes Fund Managers MENT Jukka Pihlman, Standard Chartered Bank Colin Robertson, SW1 Consulting Fabio Scacciavillani, Oman Investment Fund Lutfey Siddiqi, National University of Singapore David Suratgar, BMCE Bank International Volker Wieland, German Council of Economic Experts Katarzyna Zajdel-Kurowska, National Bank of Poland

MONETARY POLICY Iain Begg, London School of Economics Marek Belka, formerly National Bank of Poland Harald Benink, Tilburg University Mario Blejer, Banco Hipotecario Stewart Fleming, St Antony's College, University of Oxford José Manuel González-Páramo, BBVA Brigitte Granville, Queen Mary, University of London Graham Hacche, NIESR Akinari Horii, The Canon Institute for Global Studies Harold James, Princeton University Hemraz Jankee, formerly Central Bank of Mauritius Pawel Kowalewski, National Bank of Poland INDUSTRY AND INVESTMENT Philippe Lagayette, formerly Fondation de France Andrew Large, Hedge Fund Standards Board Andrew Adonis, National Infrastructure Commission Joel Kibazo, JK Associates Gerard Lyons, Policy Exchange Jean-Claude Bastos de Morais, Quantum Global Jürgen Krönig, Die Zeit Rakesh Mohan, Yale University Robert Bischof, German-British Forum Oscar Lewisohn, Soditic Athanasios Orphanides, MIT Sloan School of Management Albert Bressand, European Commission Boyd McCleary, 39 Essex Chambers Nagpurnanand Prabhala, University of Maryland Caroline Butler, Walcot Partners Luiz Eduardo Melin, International Economic Synergies Edoardo Reviglio, Cassa Depositi e Prestiti Nick Butler, King’s College, London Willem Middelkoop, Commodity Discovery Fund Richard Roberts, King’s College, London John Campbell, Campbell Lutyens Célestin Monga, African Development Bank Olivier Rousseau, Fonds de réserve pour les retraites Mark Crosby, Monash University Danny Quah, Lee Kuan Yew School of Public Policy Miroslav Singer, Generali CEE Holding Natalie Dempster, World Gold Council David Smith, formerly United Nations Shumpei Takemori, Keio University Hans Genberg, The Seacen Centre Takuji Tanaka, Japan Finance Ministry Makoto Utsumi, formerly Japan Finance Ministry Steve Hanke, Johns Hopkins University Daniel Titelman, ECLAC Tarisa Watanagase, formerly Bank of Thailand Hans-Olaf Henkel, University of Mannheim Pasquale Urselli, Mazars Ernst Welteke, formerly Deutsche Bundesbank Mumtaz Khan, Middle East & Asia Capital Partners Paul van Seters, Tilburg University

NETWORK

Bahar Alsharif David Badham Franco Bassanini Eduardo Borensztein MON ETAR Consuelo Brooke Y Colin Budd POL ICY Michael Burda Shiyin Cai David Cameron Forrest Capie Stefano Carcascio Desmond Cecil Efraim Chalamish Moorad Choudhry John Chown Vladimir Dlouhy Obindah Gershon Jonathan Grant Peter Gray Y François Heisbourg NOM Frederick Hopson ECO Matthew Hurn ICAL POLIT Korkmaz Ilkorur Karl Kaiser David Kihangire Ben Knapen Ludger Kühnhardt Celeste Cecilia Lo Turco Bo Lundgren Mariela Mendez Murade Miguigy Murargy George Milling-Stanley Winston Moore Wilhelm Nölling José Roberto Novaes de Almeida Michael Oliver Francesco Papadia Robin Poynder Poul Nyrup Rasmussen Janusz Reiter Anthony Robinson Philippe Sachs POLITICAL ECONOMY Nasser Saidi Pedro Schwartz Antonio Armellini, former Ambassador, OSCE Ruud Lubbers, Minister of State, Netherlands Vilem Semerak Frits Bolkestein, formerly European Commission Denis MacShane, Avisa Partners Laurens Jan Brinkhorst, University of Leiden Kishore Mahbubani, Lee Kuan Yew School of Public Policy Song Shanshan Peter Bruce, Business Day David Owen, House of Lords Marina Shargorodska Jenny Corbett, Australia National University Vicky Pryce, Centre for Economics & Business Research Paola Subacchi Reginald Dale, Atlantic Council Brian Reading, independent economist José Alberto Tavares Moreira Maria Antonieta Del Tedesco Lins, University of São Paulo Robert Skidelsky, House of Lords Jens Thomsen former German Minister of Finance formerly OMFIF Hans Eichel, Gabriel Stein, David Tonge Jonathan Fenby, China Research, Trusted Sources Michael Stürmer, WELT-Gruppe Jorge Vasconcelos Jeffry Frieden, Harvard University Christopher Tugendhat, House of Lords Elliot Hentov, State Street Global Advisors John West, Asian Century Institute Gottfried von Bismarck Roel Janssen, financial journalist William White, OECD Jack Wigglesworth Thomas Kielinger, Die Welt Linda Yueh, St Edmund Hall, Oxford Paul Wilson

December | ©2017 omfif.org OMFIF ADVISERS | 25 End of bull market in sight Majority sees equity market pullback occurring before the end of 2018 his month’s advisers network poll focuses on when and how the a year and ten years proposed. Despite this, 70% of our Advisers Tcurrent bull market might end. Members of the network were Network who suggested to us a timeframe agree that a correction asked: ‘Assets globally have benefited from a strong bull market in will occur in 2018, compared to 30% believing the buoyancy will 2017. When will markets see a correction and what will be the cause?’ continue for longer. Strong asset performance since 2009 has continued well into 2017. How this pullback might occur is also disputed, with causes This makes the current ‘bull run’, at 8½ years, the second longest on including the influence of disruptive technology and monetary policy record. Earnings growth, relaxed lending conditions and a gradually tightening. Underlining the unpredictability of market developments, expanding economy have combined to create an ideal environment respondents gave a wide variety of reasons such as a barely for stock appreciation. Financial history suggests bull markets are forecastable ‘black swan’ event with the escalating crisis in the Gulf not be permanent, and so a correction seems inevitable. However, cited as potentially jarring the market. Other possible factors include the timeframe provides widespread debate with anywhere between global increases in both inflation and interest rates.

Higher global inflation most likely to correct market Size of circle represents number of responses I believe that any overall correction is likely to be short-term due to the strong global underlying economic conditions. With the strengthening of Inflation the global upswing in economic activity, global Monetary policy tightening growth is projected by the IMF to increase further Indebtedness overhang to 3.7% in 2018, from 3.6% in 2017. Moreover, globally, monetary policy remains accommodative. Hemraz Jankee, formerly Bank of Mauritius

The international financial market will face a correction when inflation accelerates in major ‘Black swan’ event countries, particularly in Japan, whose inflation risk the market totally neglects. This is unlikely to happen in 2018 unless some incident breaks out in the Gulf. Akinari Horii, The Canon Institute for Global Studies End of QE QE Market correction will occur within 12 months and the major causes will be loss of confidence in Loss of faith with central bankers central bankers and reduced excess central bank Rate rises liquidity. Regardless of the trigger, the ending of the major features which have driven this extended bull market across virtually all asset classes will characterise a highly correlated downward move across markets. Colin Robertson, SW1 Consulting

Higher inflation numbers or wage inflation will start a The perceived dangers are the massive indebtedness correction in the US bond and equity markets, potentially overhang, the end of quantitative easing, and the next spring. Of course any big geopolitical event could political background of Brexit and Trump’s erratic also trigger a correction. behaviour. Olivier Rousseau, Fonds de réserve pour les retraites David Suratgar, BMCE Bank International

I expect a correction sometime in 2018, probably toward These statements were received as part of the latter half of the year. As always, the specific cause is the December poll, conducted between 4-23 probably impossible to project. November, with responses from 10 advisory Jeff Frieden, Harvard University network members.

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